Obama's Plans for Financial Industry Reform: Enhancing Consumer Protection and Limiting Federal Preemption
By Claire Prestel, Public Justice Staff Attorney
On June 17, the Obama Administration proposed a series of comprehensive reforms to the country’s financial regulatory structure—reforms intended to prevent an economic crisis similar to the one we are recovering from now.* Two of the Administration’s proposals address issues on which Public Justice has been a leader in protecting consumers and ensuring access to justice for consumers and other injured plaintiffs nationwide:
First, the Administration proposes to create a new agency dedicated to consumer protection, the Consumer Financial Protection Agency (CFPA), and to give the CFPA the authority to regulate and even prohibit mandatory arbitration clauses in consumer financial contracts. This aspect of the Administration’s proposed reforms is directly related to Public Justice’s work; we have spent years fighting abusive, pre-dispute mandatory arbitration clauses as part of our Mandatory Arbitration Abuse Prevention Project .
Second, the Administration’s proposals make clear that any regulations promulgated by the new CFPA will not preempt state statutes and rules that provide even greater consumer protection. Fighting excessive federal preemption of state-law protections has been a central aspect of Public Justice’s work as part of our Access to Justice Project.
Scope of the Problem
As we all know, the country is struggling to recover from its worst financial crisis since the Great Depression. Although there is room for debate about the merits of the government’s actions in response to this crisis, there is growing consensus about what caused it: inadequate oversight and consumer protection.
There is no single federal agency dedicated to protecting consumers. Instead, various agencies and entities charged with regulating the financial system also have consumer protection as part of their vast mandates. In practice, this has meant that agencies like the Federal Reserve—filled with alumni from Wall Street’s biggest banks—view consumer protection as a vastly inferior priority.
Mandatory arbitration is one example of what can happen when consumer protection takes a backseat to fulfilling big banks’ wish lists. Over the last several decades, the Supreme Court has issued a series of pro-business and pro-arbitration rulings, all of which expand the scope of the Federal Arbitration Act beyond what Congress originally intended. In response, a large number of companies have inserted mandatory arbitration clauses in the fine print in their consumer contracts. According to a recent Public Citizen report **, 75% of companies in eight essential industries (including credit cards, banking, and cell phones, among others) use forced arbitration clauses in their standard-form agreements.
The problems with mandatory arbitration are familiar to Public Justice and its members. Arbitration service providers are almost always selected by credit card companies, big banks, and cell phone companies—not consumers. This means that arbitration companies have an inherent incentive to favor the corporations who provide them with business. Imagine the outcry we would hear if state and federal judges were picked by one side. Earlier this year, the Supreme Court held that it violated constitutional due process to have a panel with even one judge who might have been affected by contributions to his election campaign. See Caperton v. A.T. Massey Coal Co., Inc., 129 S. Ct. 2252, 2263 (2009) (“We conclude that there is a serious risk of actual bias . . . when a person with a personal stake in a particular case had a significant and disproportionate influence in placing the judge on the case . . . .”). But one side picks the arbitration provider almost all the time.
Arbitration decisions are also subject to very little review. Once a consumer loses in arbitration, he or she faces an uphill battle to have that decision overturned. In addition, large corporations often use their forced arbitration clauses to add particularly unfair and anti-consumer terms to their standardized agreements. Many companies have used arbitration clauses to ban class actions by their customers—a practice that Public Justice and its members have been fighting in the courts. Most recently, we won a victory when we defeated AT&T’s class action ban in theConeff case in Washington State.
Federal preemption is another example of what can happen when consumer protection is not a top priority. Federal regulation of big banks and other financial institutions is often inadequate (as recent times have taught us), but banks—like many other companies—are quick to argue that even the most incomplete federal oversight is enough to prevent states from taking any action.
One example is what is known as a “rent a bank” scheme: A non-federally chartered bank that would ordinarily be subject to state consumer protection law enters into an agreement with a federal bank to rent (essentially) its name and charter. The federal bank doesn’t intervene in the other bank’s day-to-day operations, but the non-federal bank argues that it is nonetheless immune from state regulation because its agreement with the federally chartered entity brings it within the jurisdiction of federal regulators, and federal law preempts any more consumer-friendly state provision. Federal regulation is often so weak (as Public Justice staff attorney Paul Bland described here and former Power-Cotchett Fellow Tami Alpert described here that this arrangement, if successful, leaves the non-federal bank almost entirely free of oversight—and free to adopt unfair anti-consumer terms, like hefty prepayment penalties, that are permitted under federal law but prohibited by many state regulators.
We at Public Justice have been fighting runaway preemption for years as part of our Access to Justice Project. And as Kazan-Wallace fellow Matt Melamed recently explained, this work was forced into high gear during the Bush Administration, when the executive branch used federal preemption as a method to achieve silent tort reform.
What the Reform Proposals Would Do
The Obama Administration’s reform proposals include a number of components, which are described briefly below, beginning with consumer protection:
(1) Consumer Protection: The Treasury Department has proposed the creation of a new agency, the Consumer Financial Protection Agency, which would be dedicated to protecting consumers of financial products and services. The CFPA would have sole authority to enforce existing consumer protection statutes; that authority is now scattered among many different agencies. The CFPA would also be given rule-making authority under several federal statutes for which such authority is now non-existent or severely limited. As discussed above, the CFPA would have the authority to study, regulate and even ban mandatory arbitration, and its rules would be a floor, not a ceiling. States would be free to enact and enforce statutes and rules that provide greater consumer protection.
The CFPA’s goals would include, among others: (a) requiring clear, simple, concise, and reasonable disclosures from banks to consumers (and testing such disclosures on a regular basis to make sure they meet these goals); (b) requiring financial institutions to provide certain well-explained “plain vanilla” products to consumers alongside any more complex products that are offered; and (c) ensuring fairness by regulating unfair and deceptive practices.
(2) Closer Supervision of Financial Institutions: In addition to the consumer protection measures described above, the Treasury Department has also proposed bringing entities like hedge funds and private equity funds into the regulatory framework for the first time, giving the Federal Reserve more authority to regulate entities that are “too big to fail,” creating a new Financial Services Oversight Council to identify emerging risks to the financial system, imposing stricter capital requirements on financial institutions so that they have enough money on hand to weather a downturn, and eliminating the Office of Thrift Supervision, which was well-known as a particularly weak regulatory agency.
(3) Additional Tools to Respond to Crises: The Treasury Department has also proposed a new regime that will give the government some options other than bankruptcy and last-minute bailouts when big banks get into trouble.
(4) Higher International Standards: Finally, the Treasury Department has written that international cooperation, oversight, and capital standards must be improved because the banking system is highly integrated across borders.
Status of Reform
Perhaps not surprisingly, big banks have already begun to bring their significant financial weight to bear against any real reform. The president of the American Bankers Association told the New York Times that banks are going to put up a “huge fight.” Another spokesman for the industry admitted that the “optics” of resisting reasonable regulation in the midst of a crisis are “bad,” but banks have pressed on nonetheless—an anti-reform ad campaign is already under way. According to many reports, the Administration’s proposals regarding mandatory arbitration and federal preemption are high on banks’ hit list.
Many of the Administration’s proposed reforms cannot take effect without Congressional action, and legislative language has already been proposed and is working its way through Congress. These legislative efforts are in their early stages, and Public Justice does not support or oppose any legislation. Instead, and as always, Public Justice will continue to fight for access to justice in the courts—including by fighting unfair forced arbitration clauses and excessive federal preemption.
*http://www.treasury.gov/initiatives/regulatoryreform/
about the author
Claire Prestel is a Staff Attorney with Public Justice in the national headquarters in Washington, D.C. Before joining Public Justice, Claire was an Assistant General Counsel for the Service Employees International Union and was associated with the labor and civil rights firm Altshuler Berzon LLP in San Francisco.