NEW YORK (Thomson Reuters Regulatory Intelligence) - Those who fight against regulation for a living routinely trot out a few fundamental principles to fortify their arguments. One is that consumers should have free choice: the government should not prohibit products or services on the presumption that it knows better than the customer. Another is that “one-size-fits-all” solutions are bound to fail and should not be imposed on the industry or its customers.
Following these principles is wise, and helps keep free markets fair and efficient. So, it’s ironic and disturbing that these principles were ignored when the financial industry and its supporters in Congress rushed through a resolution which reversed a ban on mandatory arbitration clauses in the financial industry. Reversing the ban leaves financial institutions free to impose closed-door arbitration on all future disputes with customers, blocking recourse to the civil court system regardless of the circumstances.
A bit of background: for years, it has been industry practice that when you open a bank or brokerage account, you agree to take disputes with the bank to arbitration, surrendering your right to participate in a class-action lawsuit.
Last July, the Consumer Financial Protection Bureau (CFPB), much maligned by regulation opponents, banned these mandatory arbitration clauses on the grounds that they are unfair to consumers. But with last year’s elections there’s a new sheriff in town, and Congress this month managed to squeak out a revocation of the CFPB rule (with a tie vote broken by Vice President Mike Pence), which was duly signed by President Donald Trump.
The industry’s public posture is that arbitration is good for consumers and class-action lawsuits are bad. This is in fact true, in most circumstances. The Alternative Dispute Resolution service offered by the Financial Industry Regulation Authority (FINRA) is a model of efficient and fair dispute resolution that provides small investors an alternative to settling disputes, faster and cheaper than hiring a lawyer and going to court.
In most cases, arbitration is undeniably the best course for the aggrieved investor. But not always.
Singing the virtues of arbitration would have been a compelling argument against the CFPB rule if it sought to ban arbitration. But it did no such thing. Instead, it prohibited firms from requiring customers to waive their right to pursue litigation, by embedding it in a contract whose terms they cannot negotiate. That means that arbitration is not really Alternative Dispute Resolution, since there’s nothing for it to be an ‘alternative’ to. This is Substitute Dispute Resolution.
So if arbitration is usually in the customer’s best interest, why get all worked up about prohibiting litigation?
The plain answer is that in some cases class-action suits are more appropriate. Class-action suits have a public image roughly on par with opioids and bump-stocks on rifles, but their value comes clear in cases where customer abuse is widespread. Pick a financial industry scandal over the past five years and there’s a good chance that thousands of customers were victim to the same pattern of abuse.
Unpopular as they are, class-action suits are a legitimate avenue for pursuing civil justice and should not be limited in this way. Blocking their use deprives the customer of an important path to redress, and this is no more appropriate when done by a commercial enterprise than by a government body.
The right to litigate in court is something worth defending. Important matters of principle are at stake, and they are the very principles espoused by advocates of free markets: freedom of choice, level playing fields, no one-size-fits-all regulation. But mandatory arbitration runs counter to all these principles: it is a one-size-fits-all solution that reduces consumer freedom of choice and assumes that the firms know what is best for their customers better than the customers themselves.
Moreover, the financial industry will now have difficulty fighting future rules by invoking the principles they now find convenient to ignore. A less diplomatic writer would put it this way: it smacks of hypocrisy.
This abandonment of principle is compounded by Congress rushing the resolution through without the same level of consideration and analysis that is invariably demanded of new regulations (the CFPB spent five years studying the issue before issuing its rule). The weapon of choice was the Congressional Review Act (CRA), a little gem of partisanship that allows Congress to overturn new regulations by federal agencies and bar their reinstatement, but only within a short window of time. Passed in 1996, the CRA had only been used once (16 years ago) until this year: it has been used fifteen times since February to revoke Obama-era rules before the window closed.
So the fight to preserve mandatory arbitration is bad policy, contrary to free market principles, and was rushed through without the same level of scrutiny required of new rules. It’s also one more thing: bad for business.
Firms spend good money persuading clients and potential clients that the firm and its employees are trustworthy advisors whose main interest is their clients’ financial well-being. But an uninterrupted chain of scandals has given the industry the burden of proving its trustworthiness.
Lobbying to preserve the industry’s right to limit a wronged client’s options does not reinforce the image the industry needs to maintain. The move also threatens to undercut industry efforts to roll back so-called fiduciary rules which seek to formalize the duty of financial firms with respect to how they treat their customers. In effect, the industry is saying “we’ll act in our customers’ best interests, and when we don’t we’ll decide which path they should take to take action against us.”
Underlying in the industry’s argument is that class-action litigation is expensive for the firm and the costs will be passed on to customers. But this argument rests on the implicit assumption that eliminating mandatory arbitration clauses will lead to a flood of class-action suits, and that’s not likely. It takes time, effort, and money to establish a class-action suit, which must then be certified by the courts as eligible for class-action status. They really only make sense when arbitration doesn’t make sense, when the conduct in question is widespread.
Financial institutions could take a less coercive approach to encourage, but not mandate, the use of arbitration. They do a lot of customer education already, and could extend this to the merits of arbitration. They could also provide an incentive for customers to voluntarily waive their right to civil litigation, for instance by giving better terms for accounts opened with an agreement to settle disputes through arbitration.
Surely that fits better with a client-centered culture than dictating the rules of a divorce on the way to the altar.
In the end, arbitration is usually the best course for the client, but the CFPB failed in its bid to ban mandatory arbitration agreements and now it’s up to financial firms to disavow them.
(Scott McCleskey is a Regulatory Intelligence contributor. The views expressed are his own.)
This article was published by Thomson Reuters Regulatory Intelligence and initially posted on Nov. 14. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters