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CFPB Arbitration Rulemaking--and Potential FSOC Veto

posted by Adam Levitin

Today the CFPB finalized the most important rulemaking it has undertaken to date.  This rulemaking substantially restricts consumer financial service providers' ability to prevent consumer class actions by forcing consumers into individual arbitrations. I believe this is by far the most important rulemaking undertaken by the CFPB because it affects practices across the consumer finance space (other than mortgages, where arbitration clauses are already prohibited by statute). 

Let's be clear--the issue has never really been about arbitration vs. judicial adjudication.  It's always been about whether consumers could bring class actions.  I don't want to rehash the merits of that here other than to say that the prevention of class actions is effectively a license for businesses with sticky consumer relationships to steal small amounts from a large number of people.   For example, am I really going to change my banking relationship (and its direct deposit and automatic bill payment arrangements and convenient branch) over an illegal $15 overcharge?  Rationally, no, I'll lump it, not least because I have no easy way of determining if another bank will do the same thing to me. In a world of profit-maximizing firms, we know what will happen next:  I'll get hit with overcharges right up to my tolerance limit.  Given that consumer finance is largely a business of lots of relatively small dollar transactions, it is tailor made for this problem. Class actions are imperfect procedurally, but they at least reduce the incentive for firms to treat their customers unfairly.  

The financial services industry seems to be circling the wagons for a last ditch defense of arbitration. There appear to be three prongs to the defense strategy.  First, there will be intense lobbying to get Congress to overturn the rulemaking under the Congressional Review Act.  There's a limited window in which that can happen, however, and it will be an uncomfortable vote for members of Congress, particularly with the 2018 election looming.  This one will be an albatross for them.  Second, there's an effort afoot to have the Financial Stability Oversight Council veto the rulemaking.  And finally, if the rule isn't quashed by Congress or the FSOC, there will assuredly be a litigation challenge to the rulemaking. 

I want to focus on the FSOC veto strategy, which has just popped up in the news.  

The FSOC veto strategy is really a legal hail Mary.  The FSOC is an eleven member body that includes the heads of all of the federal financial regulatory agencies and an insurance representative.  It's chaired by the Treasury Secretary.  For the FSOC to veto a CFPB rulemaking, an FSOC member agency must file a petition with the FSOC within 10 days of the publication of the rule in the Federal Register.  The Treasury Secretary may then stay the rule for 90 days, and the FSOC must decide whether to veto before the expiry of the stay.  That means there are 100 days after the publication of the rule in the Federal Register for the FSOC to potentially veto the rule.  

In order to veto the rulemaking, there must be a 2/3 vote of the FSOC, so it will take 7 of 10 votes.  At present 4 of the FSOC members are still Democratic appointees (FRB, CFPB, FDIC, FHFA), plus the insurance representative (a Democratic appointee, but with unclear regulatory politics).  If one more seat flips within 100 days, then the override would require only votes of GOP appointees.  That's quite possible given the end of terms for the FDIC and CFPB Director Cordray's own uncertain plans. So the votes may well be there for an FSOC veto. 

But here's the thing.  The FSOC veto is subject to some legal procedures and judicial review, and I don't think it has a chance in hell of surviving such review, although it would buy the industry some time (and the affect of an overturned veto on the Congressional Review Act timeline is currently unclear to me).  Here are the most immediate problems I see for an FSOC veto.  First, the petitioning agency must have "in good faith attempted to work with the Bureau to resolve concerns regarding the effect of the rule on the safety and soundness of the United States banking system or the stability of the financial system of the United States."  Presumably the OCC would be the petitioning agency, but I could see the NCUA also joining the petition given its current leadership.

I don't think either agency can show that it has "in good faith attempted to work with the Bureau to resolve concerns regarding the effect of the rule on the safety and soundness of the United States banking system or the stability of the financial system of the United States".  The arbitration rulemaking was proposed in 2016.  The CFPB is required to consult with the prudential regulators during the rulemaking process. Have either the OCC or the NCUA in that time weighed in with concerns to the CFPB?  Apparently the Acting Comptroller recently wrote to the CFPB to raise "safety and soundness" concerns he had with the rule; I'm not sure that such an 11th hour letter is a good faith attempt.  Moreover, just saying the words "safety and soundness" concerns doesn't mean that they are actually good faith concerns.  It's hard to claim with a straight face that limiting class actions jeopardizes "the safety and soundness of the United States banking system or the stability of the financial system of the United States".  To make that claim is to admit that the US financial system would be unsound or destabilized without the ability to rip off consumers via small dollar malfeasance.

Now I'm sure that the argument can get gussied up with some story about how the plaintiffs' bar will extort good institutions right and left, but class action waivers are (1) relatively new, and the world operated just fine before them and (2) the US mortgage market hasn't been crippled without them and (3) a number of card issuers had dropped their class action waivers as part of a settlement and don't seem to have gone belly up as a result.  I'm skeptical that the rule will result in higher costs for consumers, but even if it does, that's not in and of itself a threat to safety and soundness or financial stability.  Critically, I believe that the CFPB (or potentially intervenors) could sue to block the FSOC from voting on the grounds that the petition was not in good faith.  

But even if that good faith showing about the petition can be made, however, there is still the matter of the FSOC's vote itself.  The FSOC doesn't just vote.  Each member must first be authorized to vote.  That requires the member to have "considered any relevant information provided by the agency submitting the petition and by the Bureau" and to have "made an official determination, at a public meeting where applicable, that the regulation which is the subject of the petition would put the safety and soundness of the United States banking system or the stability of the financial system of the United States at risk."  That "official determination" is another point that could be vulnerable to challenge, and separately for each agency, based on both the procedure for making the determination and the substantive support for the determination. (And if those determinations look suspiciously similar or if FOIA reveals a trail of arm-twisting from Treasury, etc....)  

Finally, if there are enough FSOC members authorized to vote and the requisite majority of members serving (not members voting) vote to veto the rulemaking, the FSOC has to publish a decision "with an explanation of the reasons for the decision."  I assume that among other things, that FSOC decision has to include factually supported findings that the petition was filed in good faith.  In any case, any and all of the FSOC decision can itself be challenged under the Administrative Procedures Act, and you'd better believe that it would be.  Given that there really is no connection between class action waivers and "safety and soundness" or "financial stability," I cannot see how an FSOC veto could possibly survive judicial review.  

These are only the first level vulnerabilities I see with the FSOC veto strategy, but there's also a more general problem:  no one really knows how the mechanics of an FSOC veto process work.  The FSOC was supposed to adopt rules implementing the veto procedure, but it hasn't.  That opens the door to lots of potential litigation challenges to the FSOC's procedure, and those challenges might well run the clock on the 100-day limit; there's certainly nothing in the statute that provides for an extension of the stay beyond that 100 days.  

Bottom line is that the financial services industry is grasping for ways to stave off the arbitration rulemaking, but the FSOC route is unlikely to succeed and could result in a lot of egg on the face of Secretary Mnuchin if he wants to push ahead with it.  

[Updated 7/12 to correct number of FSOC voting members.]


You say that there is no good faith argument against the CFPB's actions.
I say that Brett Kavanagh is a DC Circuit judge. He don't need no steenkin' good faith arguments.

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