After years of studying the issue, the Consumer Financial Protection Bureau is ready to take on binding arbitration in contracts for personal finance products.
The agency announced today it is moving forward with a plan to develop rules that could prohibit financial service providers from requiring customers to give up their legal right to sue in order to get a product or service.
How banks get you a few dollars at a time
If you are a normal person and you are still reading this, your eyes have probably glazed over, but this is a really important issue. Banks have exploited their immunity from class-action lawsuits to, either intentionally or "accidentally," siphon huge amounts of money from customers $1 or $2 at a time.
"It's tremendously important," says Lauren Saunders, associate director of the National Consumer Law Center. "Companies use arbitration clauses as a 'get out of jail free' card."
How? Say you were a financial services company that wanted to make more money, and you weren't overly concerned about obeying the law or the rights of your customers. You could target a few customers and take a lot from each of them, but then a significant number of those customers would come after you.
Even if you force customers to go through an arbitration system you've set up (which is slanted toward you, but in which, if you bilk people really blatantly, you can still lose) you're still going to end up having to settle with people and give back some of the money. People aren't going to just sit there and let you take thousands of dollars from them without a fight.
Instead, you could use a different tactic: Take a few dollars each from thousands or millions of your customers. Think of it like the embezzlement schemes in the movie "Office Space," or the film it pays homage to, "Superman III": Take a little bit of money a lot of times, and pretty soon you're talking about real money.
Very few among thousands of customers will come after you for a couple of dollars or even notice it's gone. Even if a customer is mad you took their money, only a tiny percentage will go through the hassle and expense of hiring a lawyer and coming after you for it on principle alone.
Class actions blocked
It used to be that cheating banks doing stuff like this could be dealt with by a class-action lawsuit -- customers would band together with the same legal team and go after the bank (and, yes, make millions of dollars for the attorneys in some cases) with very little effort on the part of individual consumers.
All the customer had to do was fill out a form agreeing to join the suit. The banks would be suitably chastened (or go back to the drawing board on nefarious plots), and customers would get a check for a few bucks in the mail.
But banks got smart and began writing language into the contracts for all kinds of financial products that prohibited customers from joining class-action lawsuits. Don't want to sign it? Sorry, no checking account.
Most customers signed the agreements, and life became great for the banks. They could freely siphon off millions of dollars from customers and, while they occasionally got caught by regulators and fined, they no longer had to worry as much about having to settle large class-action lawsuits with customers.
Each customer now has to individually go to an arbitrator, chosen by the bank in most cases, to settle every single, little, tiny claim. As you'd expect, few do.
"If a company charges an illegal fee to millions of people, you (won't see) millions of people finding millions of attorneys to file an individual arbitration proceeding," Saunders says. "It's not worth it for a small amount of money. Most people don't even realize the law's been violated."
Enter the CFPB
Now, the CFPB is looking to change that by beginning the long process of rulemaking to ban the practice.
"Consumers should not be asked to sign away their legal rights when they open a bank account or credit card," said CFPB Director Richard Cordray in a press release. "The proposals under consideration would ban arbitration clauses that block group lawsuits so that consumers can take companies to court to seek the relief they deserve."
While Saunders says that binding arbitration will remain -- banks still will be able to force customers to go to an arbitrator instead of a court to address individual disputes -- the rule could make it harder for banks to systematically defraud their customers, "Superman III"-style.
"Permitting group claims to go forward is an incentive to comply with the law, it levels the playing field for companies that are complying, and it gives consumers relief when they've been harmed," Saunders says. "You shouldn't have to give up your day in court and let the company push you into a biased, secretive, lawless process as a condition of getting a credit card or signing up for a bank account."
No sure thing
All this ultimately depends, though, on whether a strong rule comes out of this process. Saunders expects the affected companies to fight the rule hard, including possibly pushing Congress to put pressure on the CFPB to weaken or trash the rule altogether.
Even if the rule does make it through those hurdles, Saunders doesn't expect it to go into effect until 2017, and it may apply only to new contracts going forward. So for instance, banks could keep the clauses in place on your old credit cards, but wouldn't be able to put them in new customers' contracts.
What do you think? Should banks be able to push customers out of class-action suits?
Follow me on Twitter: @ClaesBell.