The End Of Operation Choke Point, Sort Of

The premise behind Operation Choke Point, a joint initiative between the DoJ, FDIC and CFPB, was direct enough when it launched in early 2013. Instead of going directly after certain suspect industries – such as short-term lenders, pornographers, ammunition dealers, escort services or online gambling sites – this operation focused instead on the banks that do business with them.

The program has been controversial since its inception, and now may be coming to and end with an abrupt about face from one of the agencies that support is, the FDIC.

The method of enforcement employed by Operation Choke Point was compared by the Washington Post to Elliot Spitzer’s treatment of mutual funds during his stint as the “Sheriff of Wall Street.” First foremost, Operation Chokepoint made life more difficult and unpleasant for reputable financial institutions that dealt with the aforementioned industries that pose a  “reputation risk” to their bank.  Banks, facing an ongoing and expensive investigation process, are thus pressured to swear off their cooperation with the disreputable enterprise.

While the program did yield some prosecutions – Four Oaks Bank in North Carolina was ordered to pay a $1.2 million fine, and to accept tight restrictions on its ability to do business with Internet consumer lenders – the program greatest success was in generating outrage, particularly amongst House Republicans.

“Our concern is we have a federal government that is out of control and we have bureaucrats that think they can get a swift idea and impose the heavy hand of government on legitimate business that have had no adjudication of fraud,” said Representative Sean Duffy, a Republican from Wisconsin. “You come in here and say fraudulent, fraudulent, fraudulent and you haven’t proved it all.”

However, concerns about the program were more extensive than party line’s political concerns. The Former Chairman of the FDIC, William Isaac, wrote for a Washington blog that the implications of Operation Choke Point were positively frightening.

“Operation Choke Point is fundamentally unfair to the banks and to the legal businesses that find their banking services cut off.  Once banking services are cut off to these state-licensed and regulated businesses, there is no chance for the business to appeal the decision. The company is simply in a business that, while legal, has been determined “undesirable” and therefore “high risk” by the federal bureaucracy. This Orwellian result is frightening.”

Isaac has also been particularly critical of the part of the program aimed at targeting short term lending, noting that it casts such a wide net in hunting for abusive short-term loan services that “one can only conclude that it is intended to drive all providers of alternative financial services out of business.”

He further noted that far from protecting low income families, Operation Choke Point was actually successfully going to cut of access to a needed lender of last resort for millions of people in need of one.

In the face of the widespread criticism, the FDIC partially backed down on Operation Choke Point in July of 2014,  by offering further clarification on what merchant categories financial institutions should be particularly careful in forming relationships with.

In a letter to financial institutions, the FDIC noted that the list 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.”

As it turned out, the July announcement was just the beginning of the FDIC’s operation Choke Point retreat, as it began 2015 by essentially abandoning the program entirely.

In new regulatory guidance issued to banks last week, institutions are officially instructed to evaluate their relationships with potential customers on a case by case basis, instead of on the basis of generalizations on about particular industries.

The letter further noted that financial institutions that properly manage customer relationships and effectively mitigate risks are neither prohibited nor discouraged from providing services to any category of customer accounts or individual customers operating in compliance with applicable laws. It also affirmed that FDIC examiners must provide notice in writing for any case in which an institution is directed to exit a customer relationship.

Some, are celebrating this move by the FDIC as a death-blow for Operation Choke Point – as it can no longer efficiently choke off suspect industries access to funding prima facie.  “Operation Choke Point Is Over” has been a running theme in headlines for the week or so since the FDIC released its new guidelines.

Others, however, are noting that Operation Choke Point was a team effort and the two other members of the team – the  DoJ and CFPB – have not offered any indication that they plan to back off.

“Unfortunately, banks remain spooked, and the effects of Choke Point will certainly linger,” said Jeremy Rosenblum, a partner at Ballard Spahr LLP. “Between Choke Point and ongoing [Consumer Financial Protection Bureau] supervision, payday lenders and companies in other previously targeted industries had better be able to demonstrate their legal compliance.”

Rosenblum wasn’t alone in his assessment, David Anthony, a partner with Troutman Sanders LLP concurred, noting that just because the FDIC pull back is going on, doesn’t necessarily mean lenders should fee “home-free” when it comes to working with certain industries, particularly short term lenders.

“Industry watchers are looking for the other shoe to drop in terms of regulatory enforcement investigations and actions rather than the direct approach,” he said. “We do not believe that the focus on this issue is going away anytime soon.”

In that regard he is probably right.  The CFPB is expected to announce the first round of rules they have been crafting for the short term lending industry later this year. This will mark the first time the consumer protection agency will exercise its power to regulate the industry as a whole.