The Arbitration Ban And Consumer Class Action Readiness
Originally published in the May 16, 2016 issue of Law 360.
The Consumer Financial Protection Bureau recently proposed wide-sweeping rules deterring mandatory, individual arbitration in favor of class actions across a variety of consumer finance transactions. For lenders and servicers, the implications are potentially far-reaching, extending from the point of origination through secondary market financing and distribution. While market participants may debate whether the rules will truly enhance consumer protection, it is likely that defendant financial services firms will incur a costly and time-consuming litigation process unless the industry applies at least some of the “lessons learned” from the residential mortgage-backed securities (MBS) crisis.
Given the CFPB’s broad authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act, it is likely that significant portions of the proposed rules will be adopted. As a result, lenders, servicers, debt collectors and other firms involved in consumer financial transactions must develop consistent information and data-gathering approaches to effectively organize and integrate defense strategies to lessen the financial and resource burdens of class action litigation.
Likewise, intermediaries such as banks that fund consumer loans on behalf of specialty finance originators will need to enhance their counterparty and asset diligence to ensure adherence to the growing set of regulations stemming from Dodd-Frank.
Deterring Mandatory Arbitration in Favor of Class Actions — More “Litigation Fatigue”?
In early May, the CFPB issued its long-awaited proposals effectively deterring the use of mandatory arbitration clauses in a variety of consumer loan contracts. In essence, these proposals will enable consumers to pursue class actions against financial service providers stemming from financing and related contract disputes.
The CFPB proposals are rooted in the bureau’s congressionally appointed authority under Dodd-Frank to study and issue regulations in connection with arbitration agreements, particularly the CFPB’s March 2015 study advocating consumer benefits in class actions that challenge “problematic” lending practices. The rules also follow the growing momentum from federal regulations prohibiting mandatory arbitration in most mortgage and home equity disputes and similar promulgations of other governmental entities such as the U.S. Department of Education and the U.S. Securities and Exchange Commission, among others.
The CFPB proposals would apply to a vast spectrum of consumer-related financial arrangements, including bank checking and deposit accounts, credit cards, prepaid cards, money-transfer services, certain auto and title loans, payday and installment loans, as well as student loans. The current proposals will have little to no direct impact on the residential mortgage market given Truth in Lending Act amendments that took effect in 2013. However, the sheer volume of consumer assets at issue may set the stage for another era of high-cost, time-consuming class actions against consumer lenders and servicers — many of whom already suffer from “litigation fatigue” brought on by years of MBS litigation. All participants in the primary and secondary markets for related assets should take note — the MBS crisis demonstrated how numerous parties can be subject to litigation, including originator servicers of assets, portfolio lenders, securities issuers, bond trustees and investment banks underwriting MBS.
Nevertheless, with advances in technology and a forward-looking approach to collecting information and data and applying analytics to their lending and servicing practices, financial services firms can be better prepared in advance to defend their compliance with regulations when class actions are filed.
Class Certification Still Remains a Hurdle
For defendant financial services firms, all hope is not lost because plaintiffs must first meet thresholds before class certification is granted. Moreover, these firms can be in an advanced position to gauge the likelihood of class certification (and better prepare for the merits of an action) through the use of economic and statistical analysis of their consumer asset portfolios.
Four basic elements must be established before a class is recognized and its complaint proceeds through the judicial system:
- “Numerosity” — The group of plaintiffs must be sufficiently large such that joinder of each member of the class as an individual litigants is impracticable;
- Commonality — The plaintiffs’ grievances must share a common question of law or of fact;
- Typicality — There needs to be a class representative whose claims arise from the same course of events and are typical of other plaintiffs in the class; and
- Adequacy of Representation — The plaintiffs’ class representative has interests in line with the interests of other class members.
Given the volume of underlying asset types subject to the proposed CFPB rules, it is likely that the lowest bar for plaintiffs to cross will be numerosity. Similarly, the question of commonality or adequacy of class representation may be challenged by defendants, but given the wide mandate of the CFPB in furthering consumer protections and the number of consumers potentially bringing claims, we would expect those barriers to be relatively low.
Ultimately, typicality could prove to be the most challenging aspect for plaintiffs seeking class certification given:
- The sheer magnitude of financial products subject to the proposed rules;
- The scope of related industry practices (loan underwriting and origination as well as payment collection and servicing); and
- The variety of originators and their respective corporate profiles (banks, nonbank lenders, technology companies et al.).
As with MBS litigation, defendants and their counsel will need qualified experts and litigation consultants to support them during the initial stage of this process, if not throughout the fact-finding and expert testimony phases of any litigation.
Applying Lessons Learned From the Mortgage Crisis
Assuming a class action is certified, originators, servicers, debt collectors and others subject to the proposed rules should be in a better position to effectively mount adequate defenses if they heed the lessons learned over the last several years of MBS litigation, particularly in connection with operational management and defense strategies.
- Where are the documents? Lenders and servicers must be experienced in electronically gathering and storing consumer data, loan applications, supporting documentation and servicing/collection records. Numerous bank defendants in MBS cases were negatively impacted by their inability to adequately defend themselves because they simply could not locate critical documents.
- Show me the guidelines … or else: Numerous mortgage originators and MBS issuers could not match their underwriting guidelines to the loans at the heart of the plaintiffs’ causes of action. As a result, judicially imposed timelines to produce those documents and/or demonstrated processes were detrimental to defendants in settlement negotiations and cases that proceeded to trial. Early-stage gathering of underwriting guidelines and demonstrated adherence to CFPB origination-servicing guidelines will be of significant benefit to firms in subsequently defending their lending and servicing practices.
- How big is your sample? Another important concept is the use of statistical sampling in determining the number of assets subject to plaintiff review. As witnessed during intense negotiations in numerous MBS cases, this can work for or against defendants: while defendants may argue for smaller samples of loans for plaintiff review in light of costs and resources, defendants must be careful that too small of a sample with negative findings may unfairly be extrapolated across a wider portfolio of assets.
While the Litigation Pathway Should be Well-Marked …
One could argue that MBS litigation stemming from the financial crisis was essentially one-dimensional: investor lawsuits generally focused on one asset type, residential mortgages. Nevertheless, related litigation was particularly nuanced because mortgage loan file reviews, underwriting guidelines and servicing practices were open to wide interpretation and variance. Over time, however, benchmark approaches were developed to respond to regulator inquiries, investor litigation and settlement negotiations.
While a formulaic approach to defending consumer class actions arising from the proposed rules may not be warranted given the variability of subject asset types and operations (loan underwriting, debt collection et al.), defendants, their law firms and consultants should have a more robust base of loan-level information, data and analysis much earlier in the process than during the MBS crisis. That “information foundation,” coupled with agreed-upon sampling methodologies, should result in a more timely and efficient response/rebuttal process given CFPB-promulgated asset-level standards and compliance requirements.
... Now is the Time to Prepare
A more proactive approach in advance of final CFPB rules adoption may enable defendants to prevail or lessen the financial impact of class actions. In doing so, and given the variability of asset classes and operations subject to the proposed rules (and the risks of interpretation by regulators and the courts), financial companies should now be consulting with their legal teams and litigation support firms to develop strategies demonstrating their ongoing compliance with CFPB and related regulations.
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