In addition to the passage of legislation amending the Dodd-Frank Act (DFA), disapproval under the Congressional Review Act, and a legal challenge filed in court, a fourth potential route for stopping the CFPB’s final arbitration rule from taking effect at the end of the 240-day grandfather period is garnering attention.  That route is a petition to the Financial Stability Oversight Council (FSOC) to set aside the rule.

The FSOC, which was created by the DFA, has ten voting members consisting of: the Treasury Secretary (who serves as FSOC Chairperson), the Federal Reserve Chairperson, the Comptroller of the Currency, the CFPB Director, the SEC Chairperson, the FDIC Chairperson, the Commodity Futures Trading Commission Chairperson, the Federal Housing Finance Agency Director, the National Credit Union Administration Board Chairperson, and an “independent member” with “insurance expertise” appointed for a six-year term by the President and confirmed by the Senate.  There are also five nonvoting members who serve in an advisory capacity.

The DFA provides that the FSOC can set aside a final CFPB regulation or any provision thereof on the petition of a member agency if the FSOC decides “that the regulation or provision would put the safety or soundness of the United States banking system or the stability of the financial system of the United States at risk.”  A member agency can file a petition with the FSOC to set aside a regulation if the member agency “has in good faith attempted to work with the Bureau to resolve [safety and soundness or financial system stability] concerns” and files the petition no later than 10 days after the regulation has been published in the Federal Register.

If a petition is filed, any member agency can ask the FSOC Chairperson (i.e. the Treasury Secretary) to stay the effectiveness of a regulation for up to 90 days from the filing.  For an FSOC member to vote to set aside a regulation, the member’s agency must have considered any relevant information provided by CFPB and the agency that filed the petition and made an official determination, at a public meeting where applicable, that the regulation in question would put the safety or soundness of the U.S. banking system or the stability of the U.S. financial system at risk.

A decision by the FSOC to set aside a regulation requires the affirmative vote of 2/3 of the FSOC members then serving and must be made by the later of 45 days from the filing of a petition or, if a stay has been issued, the expiration of the stay.  An FSOC decision to set aside a regulation is subject to judicial review under the Administrative Procedure Act.

On July 10, Keith Noreika, the Acting Comptroller of the Currency, sent a letter to Director Cordray in which he asked the CFPB for the data it used to develop and support its proposed arbitration rule.  In the letter, Mr. Noreika stated that a variety of OCC staff had reviewed the CFPB’s proposal from a safety and soundness perspective and expressed concern about its potential impact on U.S. financial institutions and their customers.  He also discussed the potential detrimental effects of the CFPB’s proposal, including the potential adverse effects that the increased litigation cost associated with the loss of arbitration as an alternative dispute resolution mechanism could have on the “reserves, capital, liquidity, and reputation of banks and thrifts, particularly community and midsize institutions.”  Mr. Noreika stated that he had directed OCC staff to work expeditiously with CFPB staff to examine the CFPB’s data and “determine if our concerns are allayed by the data or to work with the CFPB to resolve any safety and soundness concerns that persist.”

Mr. Noreika’s letter would appear to position the OCC as the most likely FSOC member agency to file a petition to set aside the CFPB’s final arbitration rule.  However, since five FSOC members (the CFPB Director, FDIC Chair, Federal Reserve Chair, FHFA Director and insurance representative) are currently Democratic appointees and 7 votes would be required to set aside a regulation, two current members would need to be replaced with Republican nominees for the final arbitration rule to be set aside with only Republican votes.  If the final arbitration rule is not published in the Federal Register until late August, an FSOC set aside with only Republican votes is theoretically possible since the term of the FSOC’s insurance representative member expires in September 2017 and the term of the current FDIC Chairperson expires on November 29, 2017.  (It is also possible that Director Cordray will leave the CFPB in the fall and a successor appointed by the Trump Administration will be in place.)

In the final arbitration rule, the CFPB provided the following response to comments it received on the proposed rule from the Conference of State Bank Supervisors:

An association of State regulators expressed concern that the compliance costs of the proposal could be substantial, and that requiring institutions to incur those costs could pose safety and soundness concerns for the depository institutions that the association’s members supervise.  The commenter urged the Bureau to engage in a more rigorous analysis of current and future compliance costs before finalizing the rule.  The Bureau notes that arbitration agreements are not universal, such that for the markets covered by the final rule and that are subject to the authority of State regulators, there are depository institutions that do not currently employ such agreements.  Indeed, as discussed below, the Bureau estimates that the majority of depository institutions do not use arbitration agreements.  It is evident that depository institutions without arbitration agreements are able to remain safe and sound despite their exposure to class action liability.  The Bureau has no reason to believe that depository institutions with arbitration agreements are less financially sound than those without or that requiring certain depository institutions to amend their agreements will cause them to become less financially sound.  For the reasons above the Bureau believes that increasing class action exposure for depository institutions currently using arbitration agreements will not pose safety and soundness risks.  In addition, as discussed in Part III, no class action in the Study went to trial.  As further discussed in the findings in Part VI, courts are generally able to consider the financial condition of the defendant when evaluating the reasonableness of class settlements and litigated judgments.  In addition, under CAFA, prudential regulators are afforded notice and the opportunity to comment on the proposed class settlement before the court makes a final approval decision.  These mechanisms allow for consideration of safety and soundness concerns into the class settlement approval process.

This response by the CFPB is superficial and unpersuasive.  While the “majority” of banks may not use arbitration agreements, that is because most banks are small community banks in rural areas that are typically not the target of class action litigation.  However, the CFPB’s own data in its March 2015 empirical study of arbitration showed that 45.6% of the 103 largest banks with accounts representing 58.8% of insured deposits use arbitration clauses.  It is those banks that are more likely to be the targets of class actions.

The CFPB estimates that the rule will cost 53,000 financial services companies who currently utilize arbitration agreements between $2.62 billion and $5.23 billion over the next five years to defend against an additional 6,042 class actions that will be brought by plaintiffs’ counsel.  The CFPB expects those numbers to be repeated every five years thereafter.  Second, with respect to CAFA (the Class Action Fairness Act), neither Federal Rule of Civil Procedure 23 nor 28 U.S.C. 1715 requires regulators to consider “safety and soundness concerns” when reviewing class settlement notices.  Therefore, CAFA provides no assurance that safety and soundness concerns will be addressed.