‘Operation Choke Point’ under Fire

by Ballard Spahr LLP

"Operation Choke Point," the coordinated multiagency federal effort to choke off banking services to alleged fraudsters (according to its defenders) or politically unpopular industries (according to its detractors), has come under fire from Congress and a payday lending industry lawsuit. The lawsuit was brought in Washington, D.C., federal court against the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (Fed), and the Office of the Comptroller of the Currency (OCC).

While the role of the U.S. Department of Justice (DOJ) was the focus of the House Oversight and Government Reform Committee’s staff report criticizing the program, and the Consumer Financial Protection Bureau (CFPB) has also reportedly played an important role in Operation Choke Point, the DOJ and CFPB were not named as defendants in the lawsuit.

The congressional report concluded that it is necessary to dismantle Operation Choke Point in light of its impact on lawful businesses. It cited a DOJ document that acknowledged "the possibility that banks… may have decided to stop doing business with legitimate lenders." The same document said that "solving that problem—if it exists—should be left up to the legitimate lenders themselves." The report sharply criticized the attitude that, "'if they are legitimate, they can prove it,"' calling it "patently absurd" and "reminiscent of the formulation that 'if one is not a witch, then they will sink rather than float.'" While the staff report was sharply critical of Operation Choke Point, congressional concerns about the operation have been expressed on both sides of the aisle.

The industry lawsuit was brought by the Community Financial Services Association, the leading payday lending trade group, and the largest payday lender in the country. The suit charges that, in an effort to eliminate the payday lending industry, the defendant agencies have subjected banks to various "pressure tactics," including "warning them that continuing their relationships with payday lenders will result in harsh and prolonged examinations, reduced examination ratings, and/or other punitive measures."

According to the complaint, the agencies have used "reputation risk" as the basis for their attack on the industry. But, the complaint says: "Several guidance documents… draw a distinction between 'reputation risk' and 'compliance risk,' which is the risk to the bank of doing business with customers that engage in fraudulent, deceptive, or otherwise unlawful practices. … The regulatory distinction between reputation and compliance risk makes clear that the former, if it is to have any independent function, is meant to deter banks from dealing with law-abiding merchants who, in the judgment of regulators, are held in low public esteem."

The complaint adds: "By unmooring 'safety and soundness' regulation from actual risk-taking or wrong-doing by the bank or its merchant customers, FDIC is claiming and exercising sweeping and boundless discretion to deploy its regulatory powers to deny banking services to lawful industries based on its own subjective judgments about which industries are (or, in its view, should be) unpopular with the public." It also includes similar allegations against the OCC and the Fed. The regulatory pressure by the federal banking agencies has caused numerous members of the plaintiff trade association to lose their bank relationships, according to the complaint.

The complaint claims that:

  • The agencies have failed to follow the notice and comment requirements of the Administrative Procedure Act in adopting reputation risk rules.
  • The "vague and subjective" reputation risk standard created by the agencies exceeds their statutory authority to set safety and soundness standards.
  • The guidance and communications represent arbitrary and capricious action by the agencies because they "bestow on all payday lenders the stigma of illegitimacy."
  • The agencies have violated the due process rights of the plaintiff trade association's members by depriving them of their right to pursue their lawful business free from unreasonable government interference.

The complaint seeks a declaration that the agencies have acted unlawfully in issuing the guidance and an injunction that bars them from taking any action in reliance on the guidance or informally pressuring banks to terminate their relationships with payday lenders.

Even though the DOJ is not named as a defendant, the complaint alleges that it has “acted in concert” with the agencies through the use of its investigatory authority, having served more than 50 subpoenas on banks as part of Operation Choke Point. Earlier this year, the DOJ settled its first Operation Choke Point lawsuit, which it filed against a bank that processed ACH transactions for payday lenders through an arrangement with a third-party payment processor.

In addition to requiring the bank to pay $1.2 million in monetary relief, the consent order significantly limits the bank’s dealings with third-party processors and payday lenders and other companies raising regulatory concerns. (Our prior legal alert contains a detailed discussion of the DOJ lawsuit.)


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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