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Operation Choke Point Hysteria: Are Choke Point's Critics Responsible for the Account Closings?

posted by Adam Levitin

At today's House Judiciary Committee hearing on Operation Choke Point it seemed that Choke Point's critics are conflating a fairly narrow DOJ civil investigation with separate general guidance given by prudential regulators.  In particular, Rep. Issa attempted to tie them together by noting that the DOJ referenced such guidance in its Choke Point subpoenas, but that's quite different than actually bringing a civil action on such a basis (or on the basis of "reputational risk"), which the DOJ has not done.  

There is a serious issue regarding the bank regulators' use of "guidance" to set policy. Guidance is usually informal and formally non-binding, but woe to the bank that does not comply--regulators have a lot of off-the-radar ways to make a bank's life miserable.  This isn't a Choke Point issue--this is a general problem that prudential bank regulation just doesn't fit within the administrative law paradigm.  There are lots of reasons it doesn't and perhaps shouldn't, but when it is discovered by people from outside of the banking world, it seems quite shocking, even though this is how bank regulation has always been done in living memory:  a small amount of formal rule-making and a lot of informal regulatory guidance.  By the same token, however, compliance with informal guidance is enforced informally, through the supervisory process, not through civil actions, precisely because the informal guidance is not actionable.  Yet, that is what Choke Point critics contend is being done--that DOJ is using civil actions to enforce informal guidance.  

I don't think that's correct (or at least it hasn't been shown).  But the conflation of DOJ action with prudential regulatory guidance may be creating the very problem Choke Point's critics fear.  

Bank compliance officers may be hearing what Choke Point critics are saying and believing it and acting on it.  If compliance officers believe that the DOJ will come after any bank that serves the high-risk industries identified by the FDIC or FinCEN, not just those that knowingly facilitate or wilfully ignore fraud, they will respond accordingly.  The safe thing to do in the compliance world is to follow the herd and avoid risks.  The attack on Operation Choke Point may well have spooked banks' compliance officers, who'd aren't going to parse through the technical distinctions involved.  

What matters is not what the DOJ actually does, but what compliance officers think the DOJ is doing, and they're likely to head the loudest voice in the room, that of Choke Point's critics.  So to the extent that we are having account terminations increasing after word got out of Operation Choke Point it might be because of Choke Point's critics' conflation of a narrowly tailored civil investigation with broad prudential guidance.  Ironically, we may have a self-fulfilling hysteria whipped up by Choke Point critics, who shoot first and ask questions later.  

Comments

As I mentioned in a comment on your previous post, the government hasn't told us what Operation Choke point really is. There is media speculation, lost of conspiracy theories, but not even a simple, one page press release saying "Operation Choke Point is ..."

So take a lack of definition. Add the ability of regulators to enforce informal rules. Stir in our highly partisan political climate, and you get the current confused set of accusations and denials. If the government doesn't want self-fulfilling hysteria it should officially define Operation Choke Point (of course, this won't drop all of the hysteria, much of it is politically motivated and facts have no role when political points can be scored).

You are right that regulators can apply a lot of informal pressure. But this really confirms the "slippery slope" complaints:

A bank's regulator comes in, says "here is the FDIC's list of businesses to watch out for. By the way, (with a wink) I don't like guns." The local gun store now has problems with the bank. It's all informal, no paper trail, and maybe next time the bank gets an anti-tobacco regulator.

This even shows up in Summer, 2011 FDIC Supervisory Insights. The list of high risk merchant categories is followed by a specific note that online gambling is a particular problem. If I were a bank executive I know which industry I'd drop first. See:

http://www.nytimes.com/2014/07/17/arts/television/baring-all-on-dating-naked-and-skin-wars.html?WT.mc_id=D-NYT-MKTG-MOD-79707-07-18-PH&WT.mc_ev=click&WT.mc_c=${CAMPAIGN_ID}

Actually, I think it's pretty clear that Operation Choke Point refers to a DOJ civil investigation under FIRREA and nothing else. It covers about 50 administrative subpoenas, but not any if the guidance given by prudential regulators.

I don't think there's a slippery slope here, because it's pretty clear which industries are high risk based on ACH return or chargeback rates. The DOJ Four Oaks complaint focused on some payday lenders with unauthorized transaction return rates of 30-70%. There's no slippery slope from that to a legit merchant of any sort.

I agree Operation Choke Point is most likely the DOJ investigation as you've described it, yet even you say "it's pretty clear", not "Operation Choke Point is".

I looked up the Four Oaks complaint and am a bit confused. The problem here seems to be the third party payment processor yet it looks like the bank pays a fine and the payment processor suffers no penalties. The third party processor isn't named in the civil complaint or news stories. So the payment processor can go find a new bank and it's business as usual?

This is backwards. If a third party payment processor is initiating fraudulent transactions, then the payment processor should also be a target, not just the bank. As it stands, in the Four Oaks case the real crooks, who profited the most from the unauthorized debits, are apparently free to find another bank and continue unpunished.

Assuming, of course, that Four Oaks or the third party processor actually did anything wrong. It's easier for the bank to pay a small fine and have the Justice Department as an excuse for breaking its contract with the processor (if that was an issue) than go through the bad publicity and cost of a court battle.

I don't think it's an either or matter. The third-party payment processor (TPPP) is probably also committing wire fraud and FIRREA violations, but the bank is aiding and abetting those violations (or actually given the terms of FIRREA, partaking in them), and has a legal duty under the Bank Secrecy Act/AML to undertake appropriate diligence of its customers.

I would not assume that the TPPPs will not be prosecuted. DOJ and the FTC have previously brought cases against TPPPs, and I would not be surprised if there's more to come.

The DOJ nor anyone else should be attempting to force a bank to decide whether a business is morally or politically "correct." The bank's job is to handle financial transactions. I don't need my bank fees increasing because of DOJ pressure to "clean up" the payday lenders or porn stars. If those groups are doing something illegal, then its the DOJ's responsibility to pursue them through the appropriate legal channels.

Adam. This is reach; a big one. It appears that you are attempting to put fault on the whistle blowers rather than on the agencies giving the guidance. The argument might hold water if not for the fact that there is an increasing amount of evidence indicating the banks are refusing to do business with the firearms industry. Many of the banks have adopted this posture recently, after the "informal guidance" was provided.

The FDIC did the right thing in clarifying the issue, but essentially, the damage is already done. As you have pointed out, informal guidance is enforced informally, but effectively.

Certainly, the word is out and it doesn't have to be on paper for bankers to notice. The word got out in the guidance given to bankers indicating specific industries which are "high risk"; and the bankers took note. The fact that people started talking about it makes little difference in that respect.


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