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Operation Choke Point: Payday Lending, Porn Stars, and the ACH System

posted by Adam Levitin

Pop quiz:  what do payday lenders have in common with on-line gun shops, escort services, pornography websites, on-line gambling and the purveyors of drug paraphrenalia or racist materials?  

You can read my testimony for this Thursday's House Judiciary Committee, Subcommittee on Regulatory Reform, Commercial, and Antitrust Law's hearing on Operation Choke Pointo find out. Or you can just keep reading here.  

What all of these businesses have in common is that they are considered high-risk customers by banks. What makes these industries high-risk for banks? Many of their payments are disputed. Sometimes the issue is consumer fraud, sometimes merchant fraud:  happily married men vehemently deny subscribing to porn sites or having paid for an escort service. Or a payday lenders might demand an ACH payment without authorization.  All of this matters to banks because banks make various warranties when they transmit or demand payments within the payment system. If a payment isn't authorized, the bank can be stuck with the loss. 

So here's the back story.  In early 2013 the Department of Justice commenced Operation Choke Point, a crackdown on consumer frauds. Operation Choke Point recognized that consumer fraudsters need to get paid for their crimes to pay, so choking off their access to the financial system is a great way to combat consumer fraud.  (I suggested something analogous as a general regulatory strategy in an early article.) DOJ has done this by investigating banks (resulting in one law suit to date) that provide access to the automated clearing house (ACH) payment system for payday lenders through third-party payment providers to ensure that the banks are complying with the Bank Secrecy Act/Anti-Money Laundering duty of making sure they know who their actual customer is and that the customer's business is legitimate and that the bank is not itself being used as an instrument of a consumer fraud.  In other words, this is a money laundering issue.  While we tend to think of money laundering as being about drug money or terrorism finance, money laundering concerns cover all sorts of crimes.  

The fringe right has gotten up in arms about Operation Choke Point, suggesting that it is cutting off legitimate businesses from the financial system and that DOJ has no authority to do this.  In particular, critics have pointed to banks terminating the accounts of high-risk businesses, such as porn stars, in the wake of Operation Choke Point. Of course, no one has actually been able to show that there was a causal connection with the account terminations, which might have been due to any number of other issues (as subsequent reporting indicates). Other critics, such as the inimitable Todd Zywicki, have raised the concern of a slippery slope, namely that the DOJ will seek to squeeze other politically disfavored businesses (abortion clinics, Wikileaks, Teaparty) out of the payment system. Yet other critics have complained about the unfair dragooning of banks into the role of policemen. ("Do you really expect us to look at every image on a porn site to determine if it's kiddie porn?")

Not surprisingly, these high-risk businesses and the banks that want their business have gone wailing to Congress, seeking succor and relief from the oppresive regulatory fist of the DOJ.  Or, put another way, these high-risk businesses have gone to Congress to ask to be functionally exempted from anti-money laundering regulations. DOJ is pressuring banks to take AML seriously, and that means higher compliance costs for dealing with high-risk businesses.  Some banks think it's more cost efficient to terminate accounts than to reprice them.  But unless one thinks that there is complete market failure in the banking industry, surely some of our nearly 16,000 banks and credit unions will be willing to take on these high-risk businesses as customers.  It will just be at a higher price, which is what these high-risk businesses don't like. Quite rationally, these high-risk businesses have determined that it's cheaper to make campaign contributions than to have to pay their own freight.  Politics is just a business decision. And this shows us what the uproar over Operation Choke Point is really about.  

Put succinctly, the fuss over Operation Choke Point is about whether we want to subsidize high-risk businesses such as payday lenders, escort services, on-line gun dealers, purveyors of drug paraphrenalia or racist materials, and porn sites.  Now these may all be good old American pastimes ("...the heart and soul of Springfield's in Our Maison Derriere..."), but do we really want to put payday loans and porn ahead of homeland security? Apparently some members of Congress think so.

As for the statutory authority issue, FIRREA requires that there be a predicate crime, such as a wire fraud,  "affecting a federally insured financial institution."  Courts have uniformly held that "affecting" does not require an actual loss, just a risk of loss.  Now recall that banks are making warranties about the authorization of payment (and in the ACH system, at least, about the lawfulness of the payments).  It's pretty clear, then, that consumer frauds using the ACH system are "affecting federally insured financial institutions." Of course, one would actually have to read the NACHA rules to know about the warranties, which is something I suspect none of the Operation Choke Point critics have done. There's really no question that DOJ is within its statutory authority under FIRREA to pursue consumer fraudsters by cutting off their access to the financial system through Operation Choke Point.  

So we're right back to the question, then, of whether we want to subsidize payday loans and porn at the expense of homeland security. 

 

Comments

You literally have no idea what you are talking about. It is NOT POSSIBLE to open a MSB account (required for any check cashing/payday store) at ANY bank in the US. There is no price point adjustment just a blanket ban.
The only exemption to this is if you operate 30 or more stores and your fee revenue is over $50k per year. In other words: private equity and hedge funds have a green light to open a chain: Mom and Pop are out forever. Mom and Pop that own check cashing/payday also suddenly have businesses that are impossible to sell.
As usual this is actually yet another attack on small and medium sized businesses that magically doesn't affect corporations.

Mr. Levitin: Thank you for some information on this issue. I have tried to investigate Operation Choke Point and claims around it in the past. Unfortunately, I can't find any facts about the issue, just media and blog speculation and accusations. A search for "Operation Choke Point" on the Justice Department web site gives no results, so this program apparently isn't part of "open government at the Department of Justice."

So the first problem is that I don't know what Operation Choke Point really is. Do you know where to find an actual description of the program? Preferably something from the Justice Department or whatever agency is actually running the program.

In terms of the controversy, there seem to be claims of two different things going on. One is third party payment processors and illegal transactoins / money laundering. This also overlaps strongly with opposition to payday lenders (as shown by your testimony, which uses payday lending as its prime example). From your comments this is where the lobbying effort is focused.

The other issue is apparent the apparent targeting of unpopular professions. Since the Justice Department isn't telling us what Operation Choke Point entails, we can't really say whether or not they are targeting certain professions. And facts are few and far between in the reporting of bank accounts being closed. I wouldn't be surprised if some porn stars have had bank accounts closed due to their profession, or that Operation Choke Point was used as an excuse, even if it wasn't the reason. I also wouldn't be surprised if there were other issues involved in the accounts being closed beyond the profession of the customer.

However, I don't give your "subsequent reporting" link that Operation Choke Point wasn't the reason much weight -- it's a statement by an anonymous source at a bank, not an official bank statement. These are the same banks (and I'm sure anonymous sources) which claimed around 2009 that they'd never written a fraudulent mortgage.

The problem is that regulators don't need to "officially" target professions. The very existence of the FDIC list of high risk professions along with bank executives knowing that the Justice Department is going to scrutinize their activities will be enough for many banks to refuse to do business with any of the listed professions. By my count all but two of the professions listed by the FDIC are legal in the United States, in many ways this seems to be a way to outlaw these professions by denying them access to financial services rather than honestly passing a law prohibiting the profession. Unfortunately we don't have the facts in these cases, just a few anecdotes and claims / counter claims.

In an ironic twist, I notice one high risk merchant category on the FDIC list is "credit card schemes". This seems to imply that the banking profession itself (which creates and operates most credit card schemes) is itself a high risk profession and should be given additional scrutiny.

I will note from your testimony that you refer to "online gun sales" as being targeted. The actual FDIC list states "ammunition sales" and "firearms sales". There is no "online" qualifier. So gun shops are currently on the list as much as coin dealers (which you don't qualify with "online" in your testimony).

It's funny, although sad, that if the government was "guiding" banks to terminate the bank accounts of poor persons on a blanket basis, because they generate a lot of overdrafts and bounced checks, thereby affecting federally insured depository institutions, the left would be up in arms. The rights of those whose accounts were terminated would be promoted vigorously. The impact on their lives would be the subject of a front-page New York Times piece every couple of months.

But if the targets are businesses that the left has already decided it doesn't approve of, even though "we" (to use the author's phrasing) haven't yet passed a law to stop them from doing business, it's perfectly OK to wreck their businesses through elaborate circumventions of the judicial and legislative processes.

Nothing here sounds like the rule of law in its classic, society-enhancing formulation. Nor does it sound like anything democratic, given that "we" haven't passed any law banning most of the targeted businesses. Nor does it look like the Constitutional vision most legal minds subscribe to because it completely subverts notions of due process, judicial review, right of confrontation, to say nothing of the economic liberties many conservative scholars contend for. It doesn't even look like a republican form of government because it's nothing but some non-elected agency employees threatening private parties in order to induce them to inflict damage on other private parties to fulfill the agenda of the government agencies.

It sounds more like one side gets control of the executive, but not the legislative or judicial branches, and then resorts to non-public, below-the-radar channels, without any judicial scrutiny or popular ratification, to pursue its agenda by way of threats against third parties.

Um, DOJ sued Four Oaks in a court of law and that court also had to approve the settlement. That's due process. Similarly, if a bank doesn't like a FIRREA administrative subpoena, it can challenge it.

The banks' customers have no rights that are being affected. There is no right to an account at any particular bank or even to an account at all.

As for what would happen if the shoe were on the other foot, well, the overdraft risk is an important reason why we have so many unbanked households. No one pushes the banks to ignore that risk. Moreover regulatory burdens like EFTA's paper periodic statement requirement add to bank costs for accounts and that keeps some people out of the system. No outrage there. I don't think there's a hypocrisy problem.

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