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Arbitrations v. Class Actions

The Consumer Financial Protection Bureau recently finalized a controversial rule that prohibits financial-service companies from including arbitration clauses in their contracts with consumers that block those consumers from joining class action lawsuits. The rule stops short of prohibiting all arbitration clauses. According to the CFPB, “the new rule will deter wrongdoing by restoring consumers’ right to join together to pursue justice and relief through group lawsuits.” Opponents argue that the new rule will lead to unnecessary litigation and help class action lawyers get rich while adding no benefit to consumers.

Before the rule was instituted on July 10th, financial-service companies, such as banks and credit card providers, barred customers from litigating disputes in court. Instead, consumers were required to resolve claims through a process called arbitration in which a neutral third party, or arbitrator, hears both sides of a dispute and grants one party an award. The rule’s opponents argue that arbitration is cheaper and more expedient for companies and consumers. Its proponents agree that it’s cheaper for big companies, but contend that the cost of arbitration prevents the filing of low-value claims and deters individuals from standing up to big corporations.

In securities arbitration (which differs from the consumer arbitrations described above) investors pay an average of $4,000 to $5,000 with FINRA, the chief financial regulatory authority. This includes a filing fee and a daily fee for the arbitrator’s services. Although multiple investors can join in one arbitration and divide the cost, our experience is that FINRA is not equipped to handle more than a few claimants together in one arbitration suit. The alternative is class action litigation.

A class action is a unified suit brought against a company by a group of consumers who were similarly wronged. In current news, one major U.S. bank is facing a class action suit for opening unauthorized bank accounts in customers’ names. As technology advances, class actions will be more common and much larger since small mistakes can affect thousands or even millions of consumers. The benefit of class action suits is that there is usually no charge to the group of investors, or class, because their attorney’s fees are contingent on the successful outcome of the case. If the plaintiffs lose, the attorney is not paid. One complaint is that individual investors are compensated less from class action suits than from arbitration because the damages are spread among many claimants. For example, the major U.S. bank described above is reportedly paying more than $140 million in damages—a sizeable sum on its own, but insignificant when divided more than a million ways. Another criticism is that class action lawyers sometimes negotiate lower settlements in exchange for higher attorney’s fees—anywhere from 25% to 35%. This means companies pay less, consumers receive less, and attorneys earn more.

Although there is potential for abuse in class action suits—lawyers furthering their own interest—they serve a valuable consumer protection purpose. Arbitration remains the best option for companies and may be the best options for consumers as well – especially in the securities context given the size of their claim. But either way, consumers, with the help of a securities litigation lawyer, should be able to decide the best forum for their case.

Gordon C. Young
by Gordon C. Young
Updated: October 28, 2020

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