FDIC Reverses Operation Chokepoint Merchant Rulings

Operation Chokepoint’s efforts to hit companies suspected of illegal activities where it counts – their bottom lines – may have, well, been a little choked itself this week. The FDIC removed a number of merchant types from its bank guidance, fearing listing them explicitly has impeded legitimate players from operating fairly. Find out which ones.

Efforts to crack down on illegal or illegitimate merchants by zeroing in on their relationships with banks and third-party processors appears to have gone too far, and one bank regulatory agency is looking to remedy the situation, at least as far as it can do so on its own behalf.

The Federal Deposit Insurance Corp. this week in clarifying merchant categories where financial institutions should take caution in forming account relationships with third-party processors removed the specific examples it earlier provided in its guidance. Those categories included such merchant types as payday or short-term lenders, pornographers, debt consolidators and other “risky” merchant types.

In a July 28 letter to financial institutions, the FDIC noted that the list of examples of merchant categories has led to misunderstandings regarding the its supervisory approach to third-party processors, creating the misperception that the listed examples of merchant categories were prohibited or discouraged.

“In fact, it is FDIC’s policy that insured institutions that properly manage customer relationships are neither prohibited nor discouraged from providing services to any customer operating in compliance with applicable law,” the letter states. “Accordingly, the FDIC is clarifying its guidance to reinforce this approach, and as part of this clarification, the FDIC is removing the lists of examples of merchant categories from its official guidance and informational article.”

The issue of with whom financial institutions should work has taken a broad swath in Washington, as lawmakers and regulators look to crack down on areas where crooks can launder money and conduct business that might not provide consumers a fair shake.

Last month, following an Ohio Supreme Court decision that limited the state’s ability to regulate small-dollar loans, U.S. Sen. Sherrod Brown (D-Ohio) called on the Consumer Financial Protection Bureau (CFPB) to ramp up its enforcement on payday lenders, noting that the bureau’s robust authority to regulate banks and “bank-like” entities gives it a clear responsibility to bring additional scrutiny to the market.

“It is clear that the state-based system of regulating alternative financial products contains deficiencies that run counter to the CFPB’s mission,” she wrote in an open letter to bureau Director Richard Cordray. “Herefore, the CFPB must use its robust consumer-protection authority to write rules for small-dollar loans that will fill the gaps left by inadequate state laws.”

As PYMNTS.com reported in June, the CFPB actually has skipped over regulating payday lenders directly and has instead, in partnership with the FDIC and the Department of Justice through Operation Choke Point, essentially crushing them out of existence by making it difficult for them to use money.

Operation Choke Point is viewed by many as a means to offer backdoor regulation to companies that deal in industries deemed morally suspect, including short-term lenders, pornographers, ammunition sellers, escort services and online gambling sites. By it very name, its purpose is to choke off certain industries by cutting off their institutional oxygen – money.

The focus is not on the industries themselves directly, but instead on the banks that provide them services and make it possible for them to make payments.  Without the ability to work through the banking system to make or to process payments, the businesses cannot survive.

Though enforcement under Operation Chokehold so far in court seems to be limited to lenders and lending products, other industries have complained that they are seeing their access to banking services evaporate as financial services institutions determine they would rather close accounts than face the combined wrath of the Justice Department, FDIC and CFPB.

In understanding that dilemma, the FDIC has now backed off entirely on generalizing which merchant types banks should scrutinize, essentially leaving the other agencies to defend Operation Chokepoint, whose target list of suspect industries reportedly includes fireworks sales, tobacco clubs, telemarketers, makers of racist materials, drug paraphernalia manufacturers and Ponzi schemes.