Since early 2013, the United States Department of Justice (“DOJ”) has been formally targeting banks and payment processors servicing a wide range of lawfully operating businesses that various federal agencies, including DOJ and the Federal Deposit Insurance Corporation (“FDIC”), consider “high risk,” including nontraditional financial services providers such as payday lenders. The probe, known as “Operation Choke Point,” seeks to eliminate these “high risk” industries by cutting off their access to banking services. More information regarding Operation Choke Point can be read in our previous report here.
Not surprisingly, Operation Choke Point has drawn harsh criticism from both Congress and the financial services community because it has forced banks to terminate relationships with a wide variety of perfectly legitimate merchants. In January of this year, the U.S. House of Representatives Committee on Oversight and Government Reform requested that DOJ produce numerous documents regarding its general policies and procedures involving Operation Choke Point. Based on DOJ’s disclosures, on May 29, 2014, the Committee issued its staff report entitled: “The Department of Justice’s ‘Operation Choke Point’: Illegally Choking Off Legitimate Businesses?.” In its report, the Committee found that the DOJ has taken the position that providing normal banking services to certain merchants, including payday lenders, creates a “reputational risk” sufficient to trigger a federal investigation. The report concluded that as a result of increased pressure by DOJ and federal bank regulators, banks are terminating their relationships with “high risk” merchants in order to avoid heightened scrutiny by the federal government.
The report further questioned DOJ’s authority to implement Operation Choke Point. As explained in the report:
Operation Choke Point is being executed through subpoenas issued under Section 951 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. The intent of Section 951 was to give the Department the tools to pursue civil penalties against entities that commit fraud against banks, not private companies doing legal business. Documents produced to the Committee demonstrate the Department has radically and unjustifiably expanded its Section 951 Authority.
(emphasis in original).
Operation Choke Point has also drawn the ire of the financial services industry. On June 5, 2014, the Community Financial Services Association of America (“CFSA”) filed a lawsuit seeking to end Operation Choke Point alleging that regulatory agencies and the DOJ are “engaged in a concerted campaign to drive [payday lenders] out of business by exerting back-room pressure on banks and other regulated financial institutions to terminate their relationships with payday lenders.” A copy of CFSA’s press release can be read here and the complaint can be read here. (Our previous report regarding the financial services industry’s criticism of Operation Choke Point can be read here.)
However despite this criticism, the DOJ has no plans to discontinue the program. Instead, the DOJ argues that Operation Choke Point is necessary to crack down on online payday lenders (and other “high risk” businesses) who attempt to operate in states where payday lending is illegal. According to DOJ, many online payday lenders operate in states where payday lending is prohibited by utilizing third party payment processors that have bank accounts to make direct deductions from borrower’s accounts. (Non-bank or “third party” payment processors provide payment processing services to merchants and other business entities. Typically, payment processors use their own deposit accounts at financial institutions to process such transactions and sometimes establish deposit accounts at the financial institution in the names of their merchant clients.) By using payment processors to process payday loans and debit borrowers’ accounts, online lenders can operate in states where such activity is prohibited. (Our most recent report regarding how effective anti-money laundering compliance programs can help reduce the risk that third party payment processors may be facilitating fraudulent and illegal activity can be read here.)
DOJ also argues that Operation Choke Point has been successful. On April 29, 2014, DOJ announced a settlement with Four Oaks Fincorp. Inc., which was sued as part of Operation Choke Point. According to the Complaint filed by DOJ, Four Oaks permitted a third party payment processor facilitate $2.4 billion in fraudulent and illegal online payday loans through its banking system. As a result, Four Oaks agreed to pay $1.2 million in civil penalties. A copy of the DOJ press release announcing the settlement can be read here.
While DOJ’s stated position is that Operation Choke Point is designed to eliminate online payday lenders operating in states where online lending is illegal, in reality Operation Choke Point has resulted in banks severing ties with payday lenders operating in states where online lending is perfectly legal. In fact, the House Committee’s Report concluded that DOJ is using Operation Choke Point as a tool to target all forms of online lending. As explained in the Report, “Internal memoranda and communications demonstrate that Operation Choke Point was focused on short-term lending, and online lending in particular. Senior officials expressed their belief that its elimination would be a ‘significant accomplishment’ for consumers.”