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CFPB Issues Final Report on Arbitration, Telegraphing a Ban or Limits on Arbitration. Should SEC follow Suit?
Posted on Categories Arbitration, Arbitration Agreements, News, Regulation, Statistics & SurveysTags , , , , , ,

By George H. Friedman*

Short answer: no.  For those who want a little more detail, read on.

I wrote recently on my blogs at both the Securities Arbitration Commentator and Arbitration Resolution Services about the Consumer Financial Protection Bureau's ("CFPB") study of mandatory predispute arbitration agreements ("PDAAs") in consumer financial products and services.  To again review, Dodd-Frank section 1414 bans outright PDAAs in residential mortgage contracts and section 1028 directs the CFPB to study the use of PDAAs in other consumer financial products and services and later report to Congress; the statute also vests authority in CFPB to possibly develop regulations banning, limiting, or conditioning their use.  Turns out I predicted correctly that CFPB would unveil its Final Report to Congress at its March 10th “field hearing” in Newark.

Surprise!  Arbitration is bad for consumers

To the shock of no one, the Bureau’s Final Report to Congress concludes that mandatory PDAAs are bad for consumers. The Report has several findings, including these major conclusions:

  • Three out of four consumers surveyed did not know if they were subject to an arbitration clause.
  • Arbitration clauses can act as a barrier to class actions.
  • Consumers filed roughly 600 arbitration cases and 1,200 individual federal lawsuits on average each year in the markets studied.
  • By contrast, on average, roughly 32 million consumers were eligible for relief through class action settlements in federal court each year. An average of at least $220 million per year was paid out to consumers from these settlements. For checking accounts alone, class action settlements over three years totaled over $600 million for at least 19 million consumers.
  • No evidence of arbitration clauses leading to lower prices for consumers.

Clear where CFPB is heading. 

I have no quarrel with these findings.  And it’s clear to me where CFPB is heading:  I have no doubt whatsoever that CFPB will ultimately issue regs that ban or severely limit the use of predispute arbitration clauses in contracts governing consumer financial products and services.  And you know what?  It should!  There are serious abuses that need to be addressed, as the Final Report indicates, and as I said in my previous blog posts.

Should SEC follow suit?

The ink was barely dry on the Final Report when reactions to the Report – including views on implications for securities and investment adviser arbitration – began to flow along party lines. PIABA – a bar association of attorneys who represent customers in arbitration - issued a press release supporting the Report and suggesting that the SEC get on with the business of addressing mandatory customer-broker arbitration.  NASAA – the association of state securities administrators - also weighed in on March 10th in a statement adding, “We hope the CFPB’s findings will encourage the SEC to use the authority the agency was granted in the Dodd-Frank Act to investigate the impact of similar clauses used by broker dealers and investment advisers, and prohibit or restrict their use ‘in the public interest and for the protection of investors.”  So, pressure is clearly building to compel SEC to follow what is sure to be CFPB’s lead.  Should it?  I suggest no.

FINRA arbitration is not the problem

Why do I suggest that SEC not follow lockstep behind CFPB?

1. Dodd-Frank treats securities arbitration differently. Although the operative language in Dodd-Frank provides similar guidance and direction to both the CFPB and SEC about what the agencies are to do about mandatory or forced use of PDAAs, there is a key difference: Dodd-Frank section 921 does not require the SEC to do anything about PDAAs in customer-broker contracts. This was not in my opinion a drafting oversight. Had Congress intended identical treatment, it would have either used identical language or vested rule-writing authority in a single federal agency.

2. Securities Arbitration is already regulated. The SEC for decades has regulated securities arbitration. It inspects FINRA’s arbitration program, investigates complaints, and – drumroll please – must approve any changes to the rules after a lengthy public comment process.

3. FINRA’s program is fair! In my opinion, FINRA’s arbitration program is the fairest consumer program there is.  There, I said it.  How so? As pointed out in an article I published last summer, What’s a Regulator to Do?  Mandatory Consumer Arbitration, Dodd-Frank, and the Consumer Financial Protection Bureau, 20:4 ABA Dispute Resolution Magazine 4 (Summer 2014):[1]

  • Rule 2268 governs the content and placement of arbitration clauses. No hidden arbitration clauses are permitted.
  • FINRA serves the claim on the broker with whom the investor has a complaint. This rule saves the investor time and money. Typically, other dispute resolution providers do not serve the claim on the respondent.
  • The fee structure favors the investor.
  • The hearing is sited where the investor lived when the underlying events occurred.
  • There are hearing locations in all 50 states (at least one in each state).
  • The process includes a motion-to-dismiss rule that severely limits motions made prior to the claimant resting his/her case and provides sanctions for frivolous motions.
  • Parties have access to the FINRA discovery guidesand codified discovery provisions in the Code of Arbitration Procedure for Customer Disputes.
  • The customer has the option of an all-public panel.
  • In close calls, if the investor wants an arbitrator removed for bias, he or she is removed.
  • FINRA will enforce arbitration awards in the investor’s favor.
  • Awards are public, in a searchable database, and available free of charge on the web; statistical data on the program are available on the web.
  • FINRA’s Rule 12204 allows an investor to opt out of arbitration and instead participate in a class action.

In short, the program is the model of fairness.  Don’t take my word for it.  Even critics of consumer arbitration have spoken favorably about FINRA’s arbitration system.  See http://www.indisputably.org/?p=4234 and http://www.investmentnews.com/article/20120905/FREE/120909978.  Also, FINRA’s arbitration program got high marks when measured against the “arbitration fairness index” created by Professor Tom Stipanowich, a leading authority in the arbitration field.

4. The two main problems cited in the CFPB Report don’t exist at FINRA. It’s important that reviewers bear in mind the many differences between FINRA’s arbitration system and other consumer arbitration programs. Two of the major findings in the CFPB Report – class action waivers and hidden arbitration clauses – are not problems or issues for the securities customer in the FINRA arbitration forum (see FINRA Rules 12204 and 2268, respectively).

What’s your plan, Friedman?

I suggested in my ABA article that CFPB should write rules that impose conditions on the use of PDAAs in contracts for consumer financial products and services – but not ban PDAAs outright.  I think SEC should do the same thing.  Specifically, the rules should provide: a) in a contact between a customer and an investment adviser or broker, any predispute arbitration agreement must be clearly identified, optional, and separately signed or clicked by the customer; b) a customer cannot be denied goods or services if the customer declines the arbitration option; and 3) clear procedural fairness guidelines such as already exist at FINRA must be followed in any arbitration system.  I then elaborated on what such a rule should look like, opining that four simple provisions would make for a good rule:

1. Customer choice, but before a dispute arises: the customer should have a choice about whether to submit disputes to arbitration, but this choice should be made when the contract is signed. Requiring all parties to agree to arbitration after a dispute arises – could actually harm customers because businesses offering services would sometimes decline to arbitrate, making the dispute resolution process unpredictable for the customer.

2. Clear, knowing, and voluntary agreement to arbitrate: To ensure that customers knowingly and voluntarily agree to arbitrate, SEC’s rule should require that the individual separately initial/click the arbitration agreement. Rule 2268 already governs the content and placement of arbitration clauses.

3. Promote web-based arbitration systems: an arbitration system that steers consumers to travel to a “brick and mortar” arbitration hearing to resolve disputes that typically involve modest amounts is not a good idea. It’s a particularly poor one when the consumer’s interactions with the business have been entirely online. Customers should have the option of using an online ADR system.

4. Establish procedural fairness criteria: the new rules should also require that any customer arbitration system adhere to basic standards of procedural fairness. As I’ve already stated, FINRA’s program is that model.

My advice for SEC

My parting advice to CFPB was to tread carefully and stay focused on its core mission of protecting consumers.  I offer the same advice to the SEC.  I think it will become politically untenable for the SEC to do absolutely nothing about PDAAs, especially in light of the pressure that’s been brought to bear on this issue by some in Congress, NASAA, PIABA, and others (for example the AFL-CIO).  My view is that, at a minimum, the SEC will have to study the subject (it has since 2010 been accepting comments on mandatory arbitration), and eventually require some changes (impose limits or conditions). It should not, in my opinion, ban PDAAs outright. Think about it. To ban PDAAs in customer-broker contracts, the SEC would have to find that doing so is “in the public interest and for the protection of investors.” Essentially, the SEC would be saying: “We’ve been supervising customer-broker arbitration for decades. But, you know, we just realized it’s a terribly unfair system.”

On the other hand, a finding that says, “We’ve studied customer-broker arbitration and we’ve concluded that it’s a fair process. But, you know, these few changes will make it even better” is certainly feasible.

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*George H. Friedman, an ADR consultant and Chairman of the Board of Directors of Arbitration Resolution Services, Inc., retired in 2013 as FINRA’s Executive Vice President and Director of Arbitration, a position he held from 1998. In his extensive career, he previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998. He is an Adjunct Professor of Law at Fordham Law School. Mr. Friedman serves on the Board of Editors of the Securities Arbitration Commentator.  He is also a member of the AAA’s nation roster of arbitrators.  He holds a B.A. from Queens College, a J.D. from Rutgers Law School, and is a Certified Regulatory and Compliance Professional (Wharton-FINRA Institute). 

[1] See also The Arbitration Fairness Act: a Well-intentioned but Potentially Dangerous Overreaction to a Legitimate Concern, 2013:1 Securities Arbitration Commentator 1 (June 2013).

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