Greyson K. Moore
When the dust settles, the Consumer Financial Protection Bureau's (CFPB's) proposed rule to ban pre-dispute arbitration clauses barring consumers from participating in class action lawsuits may cost banks, and other covered providers, nearly a half a billion dollars each year in judgments, legal fees, and internal staff and management time. The rule and its estimated impact on institutions, which would create additional class exposure for about 53,000 providers, was published in the Federal Register for comment on May 24, 2016. Publishing any rule for comment gives covered institutions some (albeit limited) time to assess their exposure and take steps to mitigate potential risk.
Arbitration is the most common form of alternative dispute resolution, in which a privately appointed individual-an arbitrator-is empowered to resolve claims that arise between parties to a contract. It is a means for both consumers and service providers to resolve disputes outside of the court system, saving time and expense However, many firms now include clauses in their contracts effectively making arbitration "mandatory"-eliminating the consumer's ability to litigate. These clauses are known as "pre-dispute arbitration agreements," but the CFPB aims to eradicate those that limit or restrict a consumer from participating in a class action lawsuit in the financial services industry.
The issuance of the proposed rule follows the CFPB's Arbitration Study, which was mandated by section 1028(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The study purports that arbitration agreements restrict consumers' relief in disputes with financial service providers by limiting class action litigation. It found that when compared to the millions of consumers who obtain relief through class action settlements, very few consumers ever seek relief through arbitration proceedings. The CFPB estimates that elimination of the pre-dispute arbitration agreement would, on an annual basis, result in about 103 additional class settlements in federal court.
Banks and other covered institutions, however, can mitigate the potential inflow of class action lawsuits. There are basic steps they can take to review, assess, and reduce the risk of finding themselves in the uncomfortable and costly spotlight of a courtroom.
Financial institutions should review their product offerings and identify all contracts that include a pre-dispute arbitration clause. While agreements in place prior to compliance date will not be subject to the rule, future sales of these products will be exposed to class action litigation. Care should be taken to ensure the search is comprehensive, including prepaid cards, student loan portfolios, and agreements used by vendors. For example, ancillary products such as debt protection are high-risk products likely to contain a pre-dispute arbitration clause that could easily escape internal detection.
Once a comprehensive list is compiled, compliance departments should analyze complaints for the identified products-a familiar process for the highly regulated financial services industry. Complaints provide firms with crucial information to identify where problems may lie. While there is no specific minimum number of plaintiffs required to obtain a class certification, intuition follows that class action risk is likely increased with the number of complainants. Therefore, issues that consumers frequently complain about should be flagged for additional review, since they may suggest a systemic issue and thus the potential for a substantially large affected population.
The compliance department, together with the business lines, should then complete thorough root cause analysis for any concerning trends. Effective root cause analysis must be vigorous, bringing to light the underlying system, process, or training deficiency causing the symptom(s) the consumer is complaining about. It is a necessary step to understand and uncover any exposure a company may ultimately face.
Implement Controls to Validate Consumer Debts
Disputes over debts were cited as the cause for 69 percent of arbitration filings the CFPB studied; more specifically, 40 percent involved a dispute about the amount of debt the consumer owed. As the originators of the debt being collected, most banks fail to meet the Fair Debt Collection Practices Act (FDCPA) definition of a debt collector and, therefore, are not subject to a strict interpretation of the FDCPA's requirement to investigate disputed debts. That said, the CFPB has clearly signaled its intentions to compel banks and other creditors to substantiate the debts they collect and provide debtors with appropriate information.
Now, with the potential for increased class action litigation exposure, the incentive has never been greater for institutions to close the gap between regulator expectations and strict interpretations of the FDCPA. Developing and refining existing controls to ensure transparency and accuracy of loan portfolios can provide consumers another avenue to resolve issues before they become larger problems.
Effective debt validation controls must enable staff to identify covered disputes with a clear definition of what is and is not a dispute, as well as a mechanism for capturing and routing such disputes to the appropriate areas for investigation and resolution. Investigations must be timely and thorough, identifying root causes, correcting any errors, and notifying the consumer within reasonable and explicit time frames. As importantly, institutions should strive for continuous improvement through diligent documentation and trending of dispute resolutions.
Review Existing Dispute Resolution Processes
Financial institutions would also be prudent to validate the effectiveness of their existing dispute resolution procedures. This is no more important than in the credit card line of business, where 83 percent of issuers include pre-dispute arbitration agreements, covering 53 percent of current market share.
Key to detecting and resolving systemic issues are healthy control environments that comply with the Truth in Lending Act (Regulation Z) billing error resolution procedures and the Fair Credit Reporting Act (FCRA) requirement to investigate credit bureau disputes. Banks should take a risk-based approach, leveraging previously completed risk assessments, audit results, and/or compliance assessments to determine where time and resources are best spent.
Ensure Compliant Collection Practices
Since more than 50 percent of federal statutory class claims in the CFPB's Arbitration Study concerned either the FDCPA or the Telephone Consumer Protection Act (TCPA), ensuring robust controls within collection departments is another area with a high return, when it comes to mitigating class action risk. To this end, vendor management is paramount in ensuring compliance with the FDCPA and TCPA, since service providers such as collection agencies are so often used to carry out collection strategies in today's environment. Banks must ensure thorough and ongoing due diligence is performed with their service providers, including:
Ensuring that service providers, especially collection agencies, understand and are capable of complying with federal and state laws and regulations;
Reviewing policies, procedures, internal controls, and training materials to ensure service providers conduct appropriate training and oversight of employees who have consumer contact or compliance responsibilities; and
Establishing controls and ongoing monitoring to determine if service providers are complying with their stated policies and procedures as well as state and federal laws.
Prompt action must be taken to correct problems uncovered through reviewing existing relationships and ongoing monitoring, including remediation of any harmed customers.
Financial institutions should also take a hard look at their auto dialer strategies. Both the FDCPA and TCPA restrict the times when a company may contact a borrower in the borrower's local time. However, with the pervasiveness of cell phones as consumers' preferred and often only method of contact, banks must take care in developing controls.
In an effective strategy, companies will consider not only the time zone of the area code dialed, but also the time zone of the consumer's place of residence. Additionally, since the TCPA restricts calls using an auto dialer to mobile phone numbers without the prior consent of the consumer, institutions must determine if the number was provided by the consumer at the time of the transaction that resulted in the debt. If a cell phone number is later provided by the consumer, creditors and debt collectors must make clear, preferably in writing, that they may be contacted at that number for the purposes of debt collection.
There is little doubt that, if finalized, the CFPB's proposed rules limiting the use of pre-dispute arbitration agreements will increase risk for the heavily regulated financial services industry. However, if new and existing controls are built and refined to identify consumers' concerns and provide them a means to resolve their disputes, many potential class action complaints can be rooted out and resolved before they gain momentum.
Treliant Risk Advisors, Compliance, Risk Management, and Strategic Advisors to the Financial Services Industry, brings to you New Coordinates, a quarterly newsletter offering insights and information regarding pertinent issues affecting the financial services industry. This article appeared in its entirety in the 2016 Outlook issue. To subscribe to our quarterly newsletter, please Contact Us.