In a major setback for banks, credit unions, credit card companies and many other financial firms, the Consumer Financial Protection Bureau on Thursday issued a proposal that would ban the use of arbitration clauses that prevent consumers from bringing class-action lawsuits.

The 377-page proposal, released to the media a day early, would still allow companies to offer arbitration as a way to resolve disputes, but it could no longer make it mandatory. Clauses would have to explicitly state that consumers cannot be stopped from taking part in a class-action lawsuit.

As part of its proposal, the bureau would provide specific language that companies must use in communications with consumers.

“Many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them,” said CFPB Director Richard Cordray. Image: Bloomberg

“Many banks and financial companies avoid accountability by putting arbitration clauses in their contracts that block groups of their customers from suing them,” Richard Cordray, the director of the CFPB, said in a press release. “Signing up for a credit card or opening a bank account can often mean signing away your right to take the company to court if things go wrong.”

For several decades, financial firms have used arbitration agreements to prevent consumers from banding together to sue for wrongdoing, the CFPB said. Consumers with disputes over small-dollar amounts, such as finance charges or overdraft fees, have had no remedy to seek redress, in violation of consumer protection laws, the CFPB said.

The proposal is extremely broad, covering most every type of firm in the industry, including banks, credit unions, credit card issuers, certain auto lenders, auto title lenders, payday lenders, private student lenders, loan servicers, debt settlement firms, foreclosure rescue firms, prepaid card issuers, installment lenders, virtual currency firms, money transfer services and certain payment processors. The proposal alone would cover roughly 50,000 firms.

In 2013, Congress prohibited arbitration agreements in residential mortgages and home equity lines of credit.

There is a 90-day public comment period when the proposed regulations are published in the Federal Register. The proposal does not cover mortgages or home equity lines of credit, from which Congress banned the use of arbitration agreements in 2013.

For 30 years, financial institutions have used arbitration agreements with so-called class-action waivers to effectively prevent consumers from banding together in class actions to pursue similar claims.

“Under the CFPB’s proposal, that shield would no longer be available,” said Walter Zalenski, a partner at the law firm BuckleySandler.

As part of its proposed regulation, the CFPB also plans to monitor the arbitration process to ensure it is fair to consumers.

The proposal would require that companies with arbitration clauses submit claims, awards and other related materials to the bureau. The information could potentially be published to allow the public to “monitor the arbitration process,” the CFPB said.

The agency also plans to collect correspondence from arbitration administrators to track companies that fail to pay arbitration fees or adhere to certain standards of conduct.

“Under the status quo, arbitration agreements obstruct effective enforcement of the law through class proceedings,” the proposal states. “This harms consumers in two ways: it makes consumers both more likely to be subject to potentially illegal conduct because of underinvestment in compliance activities and deliberate risk-taking by companies and makes consumers less likely to be able to obtain meaningful relief when violations do occur.”

The CFPB said that the proposal would impose increased compliance costs “including the costs of forgoing potentially profitable (but also potentially illegal) business practices that may increase class action exposure, and in the increased costs to litigation class actions themselves, including, in some cases, providing relief to a class.”

The industry has anticipated and voiced its objections to the proposal since last year, when the CFPB released an outline in October as part of a small-business review panel, and a 728-page study in March. The bureau issued four formal requests for comment as part of the arbitration study process.

The CFPB said it expects the plan to have a deterrent effect.

“When companies know they can be called to account for their misconduct, they are less likely to engage in unlawful practices that can harm consumers,” the bureau said in the press release.

The Dodd-Frank Act gave the CFPB authority to study arbitration agreements and to prohibit or restrict their use if the bureau finds it is in the public interest and for the protection of consumers.

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