A number of significant developments have recently occurred regarding Operation Choke Point, the combined effort by the Department of Justice (“DOJ”), the Federal Deposit Insurance Corporation (“FDIC”) and the Federal Trade Commission (“FTC”) to combat consumer fraud by cutting off access to banking and payment processing services for “fraudulent” businesses, including many that service certain segments of the payday lending industry.
The stated intent of Operation Choke Point, first disclosed in March 2013, is to put pressure on banks to terminate relationships with potentially fraudulent merchant customers and payment processors serving them. According to regulators, high return rates for certain transactions (e.g., ACH transactions) involving these customers is a strong indicator of fraud. Although the express purpose of Operation Choke Point is not to cut off bank access for payday lenders, many argue this has been the case in practice, with critics viewing Operation Choke Point as an effort by regulators to shut down even otherwise legal payday lenders. Operation Choke Point is seen by many as building on previous regulatory efforts against payday lenders, following guidance released by the FDIC in 2011 regarding the management of risks in third-party payment processor relationships (“FDIC Guidance”), which directed depository institutions to scrutinize the merchant customers of payment processors identified as being associated with high-risk merchant categories (for which payday lending was listed as an example).
As part of Operation Choke Point, the DOJ has sent subpoenas to more than 50 banks. In January 2014, Four Oaks Bank agreed to a settlement with the DOJ regarding allegations that it was exercising inadequate due diligence and control over payment processors and customers and willfully ignoring violations of law, agreeing to pay a $1.2 million fine and to tight restrictions on their ability to do business with payment processors serving “high-return originators.” In total, U.S. prosecutors have now opened criminal and civil probes into at least 15 banks and payment processors as part of Operation Choke Point.
Many banking industry advocates have criticized Operation Choke Point. Richard Riese, senior vice president of the American Banking Association, stated that the banking industry is “being threatened with a regulatory regime that attempts to foist on us the obligation to monitor all types of transactions,” and raised concerns that the cost of doing business with merchants customers identified as “risky” are increasingly outweighing any benefits of doing such business for many banks. Camden Fine, president of Independent Community Bankers of America, expressed similar views in a letter to the DOJ on April 7, 2014, stating that DOJ enforcement action has been overly broad and aggressive, and arguing that while “preventing fraud is a top concern,” this “needs to be balanced with ensuring that businesses and consumers that operate in accordance with applicable laws can still access payment systems.”
On May 29, 2014, the House Committee on Oversight and Government Reform (“Oversight Committee”) released a report (the “Report”) regarding Operation Choke Point. The Report, titled The Department of Justice’s “Operation Choke Point”: Illegally Choking Off Legitimate Businesses?, strongly criticized Operation Choke Point. A copy of the Report is available here.
Rep. Darrell Issa, Chairman of the Oversight Committee, called Operation Choke Point the DOJ’s “newest abuse of power,” stating that “[b]y forcibly conscripting banks to do their bidding, the [DOJ] has avoided any review and any check on their power.” Rep. Issa previously sent a letter to Attorney General Eric Holder on January 8, 2014 raising concerns related to Operation Choke Point and requesting DOJ documents relating to Operation Choke Point for the Oversight Committee’s review. The letter accused the DOJ of apparently “indiscriminately target[ing] an access point to the financial system that countless legitimate merchants rely upon simply because it is ‘faster’ than targeting the actual perpetrators of fraud,” and of using its legal authority “to create an indiscriminate dragnet that is wholly decoupled from any concrete suspicion of fraud.” Rep. Issa also stated that “[t]he extraordinary breadth of the [DOJ]’s dragnet prompts concern that the true goal of Operation Choke Point is not to cut off actual fraudsters’ access to the financial system, but rather to eliminate legal financial services to which the [DOJ] objects.” The Issa letter is available here.
The Report provided the following key findings: (1) Operation Choke Point was created by the DOJ to “choke out” businesses considered “high risk” or objectionable regardless of whether they are legal businesses; (2) Operation Choke Point has forced banks to terminate relationships “with a wide variety of entirely lawful and legitimate merchants,” with bank regulators acting in coordination with Operation Choke Point to label a wide range of merchants as “high risk” and effectively transforming the FDIC Guidance “into an implicit threat of a federal investigation;” (3) the DOJ “is aware of these impacts” but “has dismissed them;” (4) the DOJ “lacks adequate legal authority” for Operation Choke Point (largely based on Section 951 of the Financial Institutions Reform, Recovery, and Enforcement Act), with the DOJ “radically and unjustifiably expand[ing] its Section 951 authority;” and (5) contrary to public statements, Operation Choke Point has “primarily focused on the payday lending industry.” As part of the Report, the Oversight Committee also provided copies of 850+ pages of documents released by the DOJ to the Oversight Committee, which are available here and here.
The DOJ documents reveal a number of things regarding Operation Choke Point. One is the role of federal regulators in identifying banks which were targeted as part of Operation Choke Point and which received related subpoenas (e.g., the Federal Reserve Bank of Atlanta turning over a report identifying banks with high rates of return for ACH transactions). The DOJ documents also reveal that the focus on banks was justified due to limited prosecutorial resources, with DOJ Director Michael Blume stating that since each individual case takes substantial time and attention, the focus on bank cases would “deter other banks, thereby stopping the processing of transactions for fraudulent merchants,” and would “prevent the initiative from grinding to a halt due to resources used pursuing merchants and processors.” Regarding effects on legitimate businesses, a September 2013 DOJ memo acknowledged that legitimate businesses might be harmed by Operation Choke Point, but stated that “[a]lthough we recognize the possibility that banks may have therefore decided to stop doing business with legitimate lenders, we do not believe that such decisions should alter our investigative plans,” and that “[s]olving that problem – if it exists – should be left to the legitimate lenders themselves who can, through their own dealings with banks, present sufficient information to the banks to convince them that their business model and lending operations are wholly legitimate.” The Report strongly criticized this view, stating that “[s]uch an expectation – ‘if they are legitimate, they can prove it’ – is patently absurd, and reminiscent of the formulation that ‘if one is not a witch, then they will sink rather than float.’” The Report also characterized the DOJ’s Operation Choke Point efforts as “inappropriately demand[ing] that bankers act as the moral arbiters and policemen of the commercial world.”
The Report concluded that in executing Operation Choke Point, the DOJ failed to do so “in a manner that does not unfairly harm legitimate merchants and individuals” and in a manner which constituted a legitimate exercise of the DOJ’s legal authorities. The Report was unambiguous about what should be done about Operation Choke Point, stating that “[i]n light of the [DOJ]’s obligation to act within the bounds of the law, and its avowed commitment not to ‘discourage or inhibit’ the lawful conduct of honest merchants, it is necessary to disavow and dismantle Operation Choke Point.”
On May 29, 2014, DOJ spokesperson Emily Pierce issued a response regarding the Report, stating that the DOJ only investigates banks and payment processors that violate federal law and that documents released by the DOJ “suggest nothing to the contrary.” On the same day, the U.S. House of Representatives voted to defund Operation Choke Point as an amendment to H.R. 4660 (a funding bill for several agencies including the DOJ), specifically by prohibiting the use of funds to carry out Operation Choke Point. The bill was approved by the House, but has not yet been voted on by the Senate. On June 5, 2014, a group of payday lenders filed a lawsuit against the FDIC, the Federal Reserve and the Office of the Comptroller of Currency (Community Financial Services Association v. FDIC, 14-cv-00953 (D.D.C. June 5, 2014)). The complaint alleges that banking regulators, with active support from the DOJ through Operation Choke Point, have engaged in “a concerted campaign” to shut down payday lenders by using threats of investigation and prosecution to exert “back-room pressure on banks and other regulated financial institutions to terminate their relationships with the payday lenders.” According the complaint, the regulatory crackdown has resulted in more than 80 banks terminating banking relationships with payday lenders. A copy of the complaint is available here.
Though much of the focus has been on Operation Choke Point’s effect on payday lenders, some critics say that regulatory efforts to pressure banks into cutting off banking access for certain types of businesses has also affected gun businesses. A number of gun retailers and manufacturers have reported either being denied banking services or having their accounts frozen, with some contending that this is due to pressure by banking regulators to drop merchant customers identified as “high-risk” in the FDIC Guidance (which included ammunition and firearms sales). Mark Cohen, owner of Powderhorn Outfitters, a gun retailer denied a loan by its longtime bank, alleged the bank specifically stated the reason for the denial was that Powderhorn Outfitters sold guns. T.R. Liberti, owner of Top Gun Firearms Training & Supply, whose online business was dropped by a local bank, says an explanatory email from the bank stated the company’s line of business “[wa]s not commensurate with the industries we work with.” Other banks that have restricted or terminated banking relationships with gun businesses have denied taking action solely on the basis of involvement in the gun industry.