Federal Officials Tell Their Side of the Operation Choke Point Story

They came in for more bashing at a House subcommittee hearing Tuesday, but several federal government officials at least got a chance to give their opinions about the controversial Operation Choke Point, an effort by the U.S. Department of Justice supported by bank regulators that aims to cut off access to electronic payments by fraudulent merchants.

At the hearing of the House Financial Service’s Subcommittee on Oversight and Investigations, a DoJ official countered what he said were suggestions that the government’s actions against fraudulent merchants, the third-party processors that provide them with payment services, and the banks that in turn work with the processors “represented an attack on businesses engaged in lawful activity.”

“I thank you for this opportunity to clear up this misconception,” Stuart F. Delery, assistant attorney general in the DoJ’s Civil Division, said in written testimony. “Our policy is to investigate specific conduct, based on evidence that consumers are being defrauded—not to target whole industries or businesses acting lawfully, and to follow the facts wherever they lead us, in accordance with the law, regardless of the type of business involved. We think this endeavor demonstrates the importance of holding financial institutions accountable when they participate in fraudulent activities, just as we hold accountable any other entity that engages in unlawful conduct.”

Delery cited the recent case of North Carolina’s Four Oaks Bank, which the DoJ sued for allowing a third-party processor to facilitate payments for suspected fraudulent merchants. The bank received $850,000 in fees from the processor, but its merchants generated a tide of complaints. Four Oaks received hundreds of reports from consumers’ banks about unauthorized debits, according to Delery, and one group of merchants had a collective return rate in excess of 30%. The bank settled in April under an agreement that calls for it to pay $1.2 million and take steps to prevent future fraud.

But Operation Choke Point’s critics, including the Electronic Transactions Association merchant-acquiring trade group and financial-institution associations, say the program goes beyond specific cases of fraud to target businesses and industries the government finds unsavory but are legal, including payday lenders, check cashers, and others.

Officials from bank regulatory agencies, however, said that while they expect financial institutions to monitor their partner third-party processors for risky behavior, they aren’t out to say to whom banks can or cannot offer payment services. “The FDIC does not and should not make business decisions for the banks that we supervise,” Richard J. Osterman Jr., acting general counsel of the Federal Deposit Insurance Corp., said in his written testimony. “Indeed, each bank must decide the persons and entities with which it wants to have a customer or business relationship.”

Added Daniel P. Stipano, deputy chief counsel of the U.S. Treasury Department’s Office of the Comptroller of the Currency, regulator of national banks: “Currently there is great concern that banks are terminating the accounts of entire categories of customers, without regard to the bank’s ability to manage the risks posed by those customers, and some have suggested that regulators are dictating those actions. As a general matter, the OCC does not recommend or encourage banks to engage in the wholesale termination of categories of customer accounts. Rather, we expect banks to assess the risks posed by individual customers on a case-by-case basis and to implement appropriate controls to manage each relationship.”

And Scott G. Alvarez, general counsel of the Federal Reserve Board, said “it is not the Board’s policy to discourage banking organizations from offering services to any class of law-abiding financial-services consumers or businesses,” according to his written statement.

Still, Republican panel members “scolded” the regulators, according to a Bloomberg news report. Operation Choke Point is “inappropriately compelling banks to serve as a moral compass and law enforcement for our market economy,” said subcommittee chairman Patrick McHenry, R-N.C.

Maxine Waters, D-Calif., however, supported Operation Choke Point, urging the officials   to be “as aggressive as you can be,” Bloomberg reported.

The Electronic Transactions Association issued a statement disagreeing with the officials’ contentions that they are interested only in stamping out fraud. Tuesday’s hearing revealed that “the Department of Justice and other federal agencies are full steam ahead on Operation Choke Point investigations that target financial institutions instead of fraudulent merchants,” the statement says. The ETA also said, “federal law-enforcement agencies are using Operation Choke Point to target categories of disfavored merchants, and using lawful payments companies as a tool in that effort.”

On Monday, the ETA said that members terminated more than 10,000 merchants last year for fraud.