Consumer Protection Faces a 'Tsunami' in Court

A year ago today, a split Supreme Court issued a ruling that fundamentally changed the way consumers can pursue claims of corporate wrongdoing. In a 5-4 ruling in AT&T Mobility v. Concepcion, the Supreme Court said companies have the right to force consumers who sign contracts—like debit-card agreements and cell phone plans—to accept terms that require them to settle all disputes in private arbitration and waive their right to band together in class actions.

In just the first year, the ruling’s impact has been dramatic. “There is no case in the history of consumer law as harmful as Concepcion,” says Paul Bland, a senior attorney at the public interest law firm Public Justice. In a report released this week, the National Association of Consumer Advocates and the legal advocacy group Public Citizen, which represented the Concepcions before the Supreme Court, said they have identified 76 cases in the past year where potential class actions were shot down by judges citing Concepcion.

Companies have rushed to add class action waivers into the contracts or make existing clauses more bulletproof. Wells Fargo, for example, tightened up the language in its contracts in February to make clear that the only exception to arbitration is small claims courts. (The bank told the Berger Record that is policies are “are consistent with the industry.”) “There is a realistic possibility that the decision will lead to a virtual end of class actions against businesses,” Vanderbuilt law professor Brian Fitzpatrick told the audience on Apr. 26 at a conference on the topic at Cardozo School of Law in Manhattan.

In a law review article, Jean Sternlight, the director of the Saltman Center for Conflict Resolutionat the UNLV Boyd School of Law, wrote that judges have thrown out class actions because of arbitration clauses in cases involving “consumer fraud, consumer debt, violations of federal and state wage and hour legislation, and unpaid wages.” She and other advocates say individual claims are often too small for to justify a lawyer’s time—the Concepcion case involved a $30.22 bill—so consumers have little recourse.

As part of Dodd-Frank financial reform, the Consumer Financial Protection Bureau was tasked with studying the effect that mandatory arbitration for financial products have on consumers. Dodd-Frank also gave the CFPB the authority to issue rules on the matter to protect consumers if the bureau deems it necessary. This week the CFPB formally launched the study by putting out a request for input (PDF) on what it examines. Comments are due by June 23.

Sternlight says such agencies as the CFPB, the SEC, and the FTC can take some small steps to help consumers, but their mandates are limited. Only Congress, she says, can really stop the “tsunami wave”  that will wipe out class actions and the consumer protection they provide.

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Online Brokers Court Option Traders

Graphic by Bloomberg Businessweek; Data: OCC

By Margaret Collins and Alexis Leondis

Glyn O’Connell is the kind of customer online brokerage firms like TD Ameritrade Holding and Charles Schwab covet. “I’ve spent more than $10,000 in commissions in past years,” says O’Connell, a TD Ameritrade customer who lives in Brisbane, Australia, and moved from trading stocks to options and futures. “You can easily recover that, but it adds up.”

Brokerages including TD Ameritrade, Schwab, Fidelity Investments, E*Trade Financial, and Scottrade are focused on expanding their businesses beyond equities as volume from stocks has sagged. Options have gained in appeal because they’re well suited to a volatile market and help hedge against declines. Not surprisingly, the number of option contracts has hit record highs.

The competition to attract and retain active traders, rather than those who buy and hold, has intensified, according to an August study by Celent, a financial research and consulting firm. While about 21 million U.S. households held stocks outside retirement accounts in 2009, less than 10 percent are active traders, according to estimates by Aite Group, another research outfit. “Options are kind of like the crack cocaine for brokerage firms,” says Andrew Stoltmann, a securities attorney in Chicago. “They’re easy money, huge commissions, and they tend to be extremely addictive for those who actually trade them.”

Options are contracts that give buyers the right, without the obligation, to buy or sell a security, a commodity, or the cash value of an index at a set price by a specific date. Investors use them to generate income, speculate on market performance, or to hedge risks. Javier Paz, a senior analyst at Aite, says investors can lose money faster trading derivatives such as options and futures if they don’t know what they are doing.

Trading volume for options has risen every year since 2002, and was up 22 percent through October, according to the OCC, the Chicago organization that clears and settles all option trades. In the first 10 months of the year, equity trading volumes on the New York Stock Exchange were down 14 percent, on average, and 9.1 percent on the Nasdaq.

The Celent study shows that option traders at Schwab, the largest independent U.S. brokerage by client assets, trade more frequently and have more assets than its average retail clients. A 2010 survey prepared for the Options Industry Council, an industry education group, found that option buyers averaged 31 trades a year, compared with 24 for other investors. Brokers like options because they generally carry higher commissions than plain-vanilla stock trades. TD Ameritrade, for example, charges $9.99 for each online stock trade, according to its website. Option orders cost $9.99 plus 75? per contract. Some clients are also charged a $19.99 commission at the time they exercise their options, according to spokeswoman Kim Hillyer.

To court those hooked on options, industry heavyweights are buying smaller rivals or expanding their in-house capabilities. TD Ameritrade, the No. 3 online brokerage in the U.S., paid about $750 million for Thinkorswim, an option trader, acquiring 87,000 retail client accounts, about two and a half years ago. Although some clients complained of glitches during the integration, TD Ameritrade Chief Executive Officer Fred Tomczyk says the acquisition has been a success: Derivatives trading increased to 32 percent of daily trades in fiscal year 2011 from 14 percent in fiscal 2009.

Fidelity, the mutual fund company that is also the nation’s second-largest online broker, rolled out enhancements this summer to the Web-based version of its active trader platform. The firm says average daily option trades have increased at a compound annual growth rate of about 21 percent in the past five years. In a deal that closed Sept. 1, Schwab bought OptionsXpress Holdings, which had 397,400 client accounts, for about $710 million. “Our interest in options is a direct result of client interest,” says Alison Wertheim, a company spokeswoman. “We’ve seen a much bigger appetite among affluent investors.”

E*Trade and Scottrade are hosting special events to familiarize customers with options. Still, Stoltmann, the securities attorney, believes most brokerage firms’ clients don’t really understand the potential downside of derivatives. “I don’t think most investors appreciate the true risks of these things,” he says. “It’s like rocket fuel on a fire, and people can be wiped out very, very quickly.”

The bottom line: Brokerages are looking for increased business from option traders to offset a decline in equity trading volume.

Collins is a reporter for Bloomberg News. Leondis is a reporter for Bloomberg News.

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