“Operation Choke Point” (OCP) is an interdepartmental initiative by the U.S. Department of Justice (DOJ) and federal financial services regulators to discourage financial intermediaries from dealing with consumer fraud-plagued industries. In an August 4 Heritage Foundation Legal Memorandum, I discuss the misapplication of this potentially beneficial project and recommend possible measures to reform OCP.
If OCP properly focused on helping financial intermediaries better identify indicia of fraud, it would be a laudable initiative. A recent report by the House Committee on Government Oversight and Government Reform, however, reveals that financial services agencies, such as the Federal Deposit Insurance Corporation, have under the aegis of OCP created lists of disfavored but lawful industries. Payday lenders are on the list, but so are such business categories as firearms sales, ammunition sales, and credit repair services, to name just a few. Apparently third party financial intermediaries may have been “encouraged” by federal regulators not to deal with firms in “disfavored” sectors. To the extent this is happening, it raises serious rule of law concerns. Regulators have no legal authority to direct private financial services away from government-disfavored but fully legal activity – such actions promote unfair legally disparate treatment of commercial actors. Moreover, financial intermediaries and the firms they are pressured into “choking off” suffer welfare losses from such conduct, as do the consumers who are denied access to (or pay higher prices for) desired goods and services supplied by the “choked off” merchants.
Another problem associated with OCP is the Federal Trade Commission’s recent litigation against lawful payment processors and other financial intermediaries for dealing with businesses allegedly engaged in fraud. The FTC has taken these actions without proof that the intermediaries knew that their clients were engaging in fraud. The FTC’s actions also may be undermining the usefulness of private sector self-regulatory efforts – embodied, for example, in April 2014 guidelines by the Electronic Transactions Association providing underwriting and monitoring standards that could help payment processors better spot fraud.
My Heritage Legal Memorandum suggests the following measures could reorient OCP in a socially beneficial direction:
- DOJ and all Financial Fraud Enforcement Task Force agencies (federal regulators) should inform the bank and non-bank financial intermediaries they regulate that they are rescinding all lists of “problematic” industries engaging in lawful activities (for example, legal gun sellers) that may trigger federal enforcement concern.
- In implementing OCP, the federal regulators should state publicly that they oppose all discrimination against companies on grounds that are not directly related to a proven propensity for engaging in fraud or other serious illegal conduct.
- In implementing OCP, if backed by empirical evidence, federal regulators should issue very specific red-flag indicia of fraud by merchants which, if discovered by financial intermediaries, may justify termination of the intermediaries’ relationships with those merchants, as well as informing the appropriate regulatory agencies. This guidance should clarify that the onus is not being placed on the intermediaries to uncover the indicia and that the intermediaries will not be subject to federal investigation or sanction if fraud by the merchants subsequently is revealed so long as the merchants acted with reasonable prudence, consistent with sound business practices.
- The FTC should issue a policy statement providing that it will not sue payment processors based on alleged fraud by merchants unless there is evidence that the processors knowingly participated in fraud. Further, the statement should express a preference for deferring in the first place and whenever reasonable to industry self-regulation.
Adoption by federal regulators of recommendations along these lines would protect consumers from financial fraud without hobbling legitimate business interests and depriving consumers of full access to the legal products and services they desire.
