In their fight over mandatory arbitration, Congress and the Consumer Financial Protection Bureau are both missing the point. Congressional Republicans and the Consumer Financial Protection Bureau are clashing over a question that has implications far beyond the world of finance: How far can companies go to protect themselves from customer lawsuits? Neither side has got the answer quite right. If you’ve ever signed up for a credit card, you’ve most likely skipped through the boilerplate contracts at the center of the controversy. They’re mostly concerned with commercial terms such as interest rates and fees. These standardized
conditions facilitate trade and save everyone time and money. Increasingly, though, the agreements include something else: a clause requiring consumers to resolve disputes in private arbitration, not in court. In some markets, the practice has become so ubiquitous that customers no longer have any choice. This is troubling, because arbitrations have no juries, no rules of evidence and no straightforward method of appeal to the courts. They’ve also been known to go badly wrong. Enter the CFPB, which issued a rule earlier this month saying that financial companies can’t ask consumers to sign contracts waiving their right to participate in class actions. On the face of it, this makes sense, given that such actions -- which bundle numerous complaints in a single lawsuit -- can be the only way for plaintiffs with meager resources to gain redress. It would also bring the U.S. more in line with the U.K. and other European countries, where mandatory arbitration clauses are typically considered invalid.
conditions facilitate trade and save everyone time and money. Increasingly, though, the agreements include something else: a clause requiring consumers to resolve disputes in private arbitration, not in court. In some markets, the practice has become so ubiquitous that customers no longer have any choice. This is troubling, because arbitrations have no juries, no rules of evidence and no straightforward method of appeal to the courts. They’ve also been known to go badly wrong. Enter the CFPB, which issued a rule earlier this month saying that financial companies can’t ask consumers to sign contracts waiving their right to participate in class actions. On the face of it, this makes sense, given that such actions -- which bundle numerous complaints in a single lawsuit -- can be the only way for plaintiffs with meager resources to gain redress. It would also bring the U.S. more in line with the U.K. and other European countries, where mandatory arbitration clauses are typically considered invalid.
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Problem is, the CFPB's solution assumes that U.S. class-action law works well, which it doesn’t. Unlike most other developed countries, the U.S. lets courts award large punitive damages, doesn’t require unsuccessful plaintiffs to pay defendants’ costs, and allows classes to include customers who haven’t actively agreed to participate -- all of which leads to too much expensive litigation. Lawyers can end up gaining more than aggrieved customers, incurring costs that can get passed on to consumers as higher prices. What to do? Simply repealing the CFPB rule and leaving the current system in place, as Republican legislators propose, wouldn’t be an improvement. The right answer starts with tort reform. Congress should make it harder to form classes on an opt-out basis, put limits on damages and lawyers’ fees, and let courts tell the losing side to pay the opponent’s legal costs. Once that’s done, the CFPB’s rule would work well, because there’d be no good reason to force consumers away from the courts. Firms and their customers could choose the appropriate venue -- be it the courts, arbitration or mediation -- case by case. But the CFPB can’t get to this outcome by itself. The larger problem is one that only Congress can solve.