White Paper: Examining the Data Behind the CFPB’s Arbitration Rule

On July 10, 2017, the Consumer Financial Protection Bureau issued a Final Rule in which it prohibited mandatory arbitration agreements between financial services companies and consumers that have disputes with one another. The Rule complements a detailed analysis of the costs, types, and impacts of class action lawsuits and individual arbitration procedures that the Bureau conducted in 2015. The primary goal of this mandate, which went into effect on September 18, was to encourage large groups of consumers to take companies to court if they feel they have a dispute. Below is a cursory analysis of some of the data and methods in the report, as well as the differences between arbitration and class action suits.

Of the 158 cases in which arbitrators gave a decision regarding an affirmative claim by a consumer, there were 32 in which arbitration provided compensation to consumers. The CFPB report detailed that the average and median awards for those that undertook arbitration were around $5,400 and $2,700, respectively. Additionally, consumers that used attorneys in arbitration cases were more likely to receive a settlement, and more likely to be awarded relief on their claims. Compensation in class action suits, however, was far less generous. The CFPB estimated approximately $1.1 billion in cash payments to about 34 million class action participants, which means an average of around $32 per participant in a class action suit. On a per consumer basis, it appears that arbitration compensates the average consumer much more.

In the CFPB’s sample of arbitration cases, consumers were represented by counsel about 63.2 percent of the time. These numbers vary widely based on industry and type of dispute. In the case of private student loans or small-dollar loans, the number of consumers represented by an attorney skyrocketed to around 95 percent. There are caps in place for what consumers are required to pay in arbitration, and those caps vary based on the amount in question. For a dispute up to $10,000, for example, consumers are capped at having to pay $125 in arbitration fees, and the capped amount gradually rises as the amount of money in question goes up. However, legal costs for consumers that are represented by an attorney during arbitration are not quantified. In the case of class action suits, the findings differed substantially, with attorneys receiving a substantial portion of the settlements. The 419 class-action suits billed about $425 million in lawyers’ fees, which rounds out to just over $1 million in legal costs per case. 79 percent of the 419 settlements analyzed had gross relief between 0 to $1 million, with average legal fees as a percentage of settlement at about 45 percent among those majority groups. At groups with a higher payout, this rate does shrink, so the report is correct in claiming that, as settlement sizes increase, legal fees as a percentage of settlement relief go down. Additionally, the CFPB showed that the majority of the total members involved in class action suits participated in larger ones, and are less affected by the substantial legal fees that almost always accompany them. However, there still are millions of class action participants that are on that upper end of the distribution.

The CFPB then examined the time (in days) between filing and settlement, partitioning the data points out by volume of the settlement. They noted that when the size is smaller, the time it takes for a suit to settle is shorter. However, the mean time is still well over a year, at 557 days. For some of the largest settlements (greater than $100 Million), the mean time between filing and settlement was almost four years, at 1,455 days. However, there were very few of these cases (n=7), and the overall average time to a settlement in a class action suit was 690 days, which is just shy of two years. In contrast, the resolution of all of the hundreds of various arbitration cases took far less time. The mean time for an arbitration dispute for all product markets to be resolved was approximately 142 days. Stayed (not due to bankruptcy) proceedings had the longest average time to resolution at 278 days, or just over nine months. These findings suggest that resolving something in arbitration is, on average, faster than settling class action lawsuits.

Finally, the OCC also reviewed the Final Rule and outlined other potential costs to consumers, as well as methodological errors in the CFPB’s original study. The CFPB, which referenced a working paper by former CFPB Economist Alexei Alexandrov, used his model to show that no statistically significant evidence suggested that firms that eliminated mandatory arbitration procedures would pass those increased costs onto consumers. OCC tested that claim, looking at the TCC (Total Cost of Credit) and replicating many of the methods in the Alexandrov writing. Their independent review found that the CFPB’s analysis, supported by the Alexandrov paper, was mostly correct. However, his paper did explain that the (statistically insignificant) regression coefficients and their standard errors could have economic significance, which means that their values were large enough to warrant further scrutiny. The model suggested that the expected TCC for a customer that obtained a new credit card with a bank that settled was about 3.43 percentage points higher than a customer who signed for a new card with a bank that did not settle. To corroborate this, the OCC included a table in which, if there was an increase in TCC, the probability that it would be at least three percentage points is around 56 percent. It is important to note that the likelihood of an increase is very much statistically insignificant, but the economic effects of an increase in TCC would be substantial. The OCC summarizes the table results by saying that they believe that, with the passing of the Final Rule, “the average consumer faces a risk of a substantial rise in the cost of their credit cards.” So, while an increase may not be very probable, it would have a large impact if it did happen.

While the CFPB’s Final Rule comes with a tag of consumer friendliness, the overall price tag of class-action lawsuits is substantial, with payout being comparatively small to compared to arbitration procedures and wait times before the payouts being substantially longer. While it is a popular argument that consumers may not feel comfortable going through the arbitration process, there are hundreds of AAA arbitration disputes every year. Though some impacts, like the Total Credit Cost that consumers could face, are unclear, the data suggests that, on a per-consumer basis, arbitration procedures are superior.

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