Consumer Groups Push for Expanded Rights to Sue Financial Firms

Consumer groups are lobbying the Obama Administration to expand the ability of consumers to file lawsuits against financial companies that sell them mortgages, credit cards, home equity loans and other financial products that fail to meet minimum government sales, marketing and disclosure standards.

“We need to get away from…gimmicks, tricks and traps,” said Lauren Saunders, managing attorney at the National Consumer Law Center in Washington, D.C. “We ought to have some common sense rules and we ought to have consequences for people who violate them.”

But banks warn the proposals could limit lending and raise borrowing costs, especially if they lead to a new wave of class action lawsuits.

“You may have a customer here and there that's able to win a lawsuit,” said Wayne Abernathy, executive vice president at the American Bankers Association. “But overall what you're going to do is raise the cost of everything as [banks] take defensive measures to protect against the potential lawsuit. There are more papers to fill out. The standards to get a loan become raised significantly. It becomes harder to get a loan, the costs go up, the quality of services will decline.”

Giving individuals the right to file civil suits against a company that sells a “faulty” consumer financial product is an existing legal option in some circumstances, such as when a company lies about terms and conditions.

But if adopted by Congress, the new consumer proposals would expand customer opportunities to file lawsuits, supplementing existing government enforcement options. In particular, consumer advocates are targeting products and practices they consider “predatory.”

“It’s really about changing the behavior on the front end,” when such products are being created, marketed and sold, said Gail Hillebrand, financial services campaign manager for Consumers Union.

Cora Ganzglass, legislative director of the National Association of Consumer Advocates, added, “A threat of a lawsuit creates a self-policing of industry.”

Consumer groups want the Obama Administration to include expanded legal remedies in its forthcoming plan to reform regulation of financial markets. As part of the plan, the administration is considering creating a new agency to regulate financial products, a “Financial Product Safety Commission,” similar to the existing Consumer Product Safety Commission, which regulates the safety of toys, appliances and other products.

People familiar with the proposals said new legal remedies for “faulty” financial products could be included in the authority to create a financial products commission or could be given to existing regulators, such as the Federal Reserve, the Securities and Exchange Commission and the Federal Trade Commission.

Because of the current public and political backlash against financial companies in the economic crisis, advocates are already winning some new consumer protections in financial products.

For example, the credit card reform bill signed into law by President Obama on Friday requires a lender, for the first time, to consider a customer’s ability to pay when issuing a card or increasing credit limits.

Also, a new House mortgage reform bill would create a new “net tangible benefit” standard for lenders refinancing a loan. It says that they may not extend credit “in connection with any refinancing of a residential mortgage loan unless the creditor reasonably and in good faith determines that the refinanced loan will provide a net tangible benefit to the consumer.” The measure would order bank regulators to come up with a definition of “net tangible benefit.” It also includes an “ability to pay” provision.

Finally, in a new proposal to regulate derivatives markets -- for options, futures, credit default swaps and other financial instruments that derive their value from some underlying asset or security -- the White House has called for applying so-called “suitability” requirements in derivatives sales.

The suitability rule is long-standing in securities markets. It requires Wall Street firms to confirm that an investment is “suitable” for an investor -- that at a minimum, it is not so complex that an investor can't understand how it works, but if he ends up buying anyway, suffers financial hardship as a result. The rule generally limits sales of more complicated investments to more sophisticated investors, such as insurance companies, pension funds and wealthier people who can pay lawyers, analysts and advisors to review them.

“Current law seeks to protect unsophisticated parties from entering into inappropriate derivatives transactions by limiting the types of counterparties that could participate in those markets,” the Treasury Department said in releasing the new derivatives plan. “But the limits are not sufficiently stringent.”

Consumer advocates and financial industry sources said that such rules -- or versions of them -- likely will end up in the Administration’s broader proposal for reforming financial regulation. Such provisions generally would not allow a consumer to sue a firm over a mortgage or other product if he suffered financial harm because of his own personal circumstances, such as losing his house to foreclosure after being laid off from a job and becoming unable to make monthly payments, or because of bad practices by a consumer, such lying about income or assets.

Rather, such proposals would mandate new minimum standards for disclosure, terms, customer profiles and other aspects of structuring, marketing and selling consumer financial products. If regulators determined a company violated them and a customer suffered financial harm as a result, the customer would have the right to sue.

If a consumer financial product “is not harmful, it’s not going to set [a customer] up to fail,” said Saunders of the National Consumer Law Center.

In theory, a customer could file suit even without any government investigation and ruling, if the customer suspected a company violated the rules. More likely, sources said, plaintiffs’ lawyers would file class action suits on behalf of a group of costumers, the more common procedure.

“I think in the end you have to recognize if you open up that new avenue, you've opened up new opportunities for the trial lawyers and a whole new world of deep pockets,” said the ABA’s Abernathy.

A spokesman for the American Association for Justice, a Washington trade group for trial lawyers, declined to comment on the consumer proposals, saying they had not yet been formally proposed by the Administration -- and as a result the group had not yet had an opportunity to study them.

The White House plans to send Congress its regulatory reform package in June. The plan is also expected to include proposals to give the Federal Reserve additional powers to regulate big, integrated financial firms that are “systemically important” to the global financial system, as well as proposals for taking over and closing such firms outside of the bankruptcy process if they fail.

“We're at the beginning of working through this,” Treasury Secretary Timothy Geithner told a House subcommittee on Thursday. “But the objective is, which is the most important thing, is that we have better designed rules to protect consumers that are in force much more effectively and evenly across the entire financial system.”