The title of the operation suggests a slow and painful cut off to the air supply, which is the idea behind the metaphor of banks being the “choke point” by removing access to its financial products and services to high-risk businesses. Banks’ responsibilities in this arena are nothing new as banks have been required to spot the bad guys, provide tips to law enforcement and report on them using the Suspicious Activity Reports (SARs) since 1992.
We all are aware of how the banks’ watchdog concept has evolved as a result of the September 11 terrorist attack. In recent years the world of Bank Secrecy Act (BSA) compliance may have on its surface seemed to be stagnant as compared to the consumer compliance changes lead by the Consumer Financial Protection Bureau (CFPB) as a result of Dodd Frank Wall Street Reform and Consumer Protection Act. But as we dive into recent BSA related guidance, advisories, and regulatory enforcement actions, it is clear that the focus is back on BSA. Operation Choke Point is proof of the government’s continued reliance on banks as the first and most effective line of defense.
The concept is not new but Operation Choke Point’s twist is. Where the line gets blurry is Operation Choke Point’s predicament and target.
To get a better understanding let’s talk about Operation Choke Point’s origin. According to the Wall Street Journal the Justice Department launched the Financial Fraud Enforcement Task Force (FFETF) initiative in early 2013. Its initial focus was on payday outfitters and other short-term lenders. The crack down had been long awaited. The CFPB’s analysis released in March documents that the average payday loan annual percentage rate is above 390 percent and that four out of five payday loans are rolled over or renewed within 14 days.
The high cost of payday loans, the reality of loans paid by new loans support, and the need to regulate the industry to protect consumers are hot topics. While picking on payday lenders may not be a surprise, according to the Committee on Oversight and Government Reform report findings issued on May 29, 2014, the targeted industries also include other lawful but high-risk lines of business and industries otherwise objectionable by the Administration.
Who are the high-risk or otherwise objectionable customers, how are the banks pressured and what have been the results of Operation Choke Point so far?
The Federal Financial Institution Examination Council Bank Secrecy (FFEIC) BSA/Anti-Money Laundering (AML) examination manual lists a number of specific customers and entities potentially vulnerable to money laundering or terrorist financing by the nature of their business, occupation, or anticipated transaction activity. The customers and entities that have been on the banks’ radar and incorporated in the risk assessments, are foreign financial and nonbank financial institutions, senior foreign political figures, nonresident aliens, accounts of foreign individuals, domestic and foreign deposit brokers, cash intensive businesses, nongovernmental organizations, charities, and professional service providers. Operation Choke Point added a number of sectors such as firearms and ammunition sales, coin dealers, paraphernalia sellers, internet gambling, and porn merchants.
The regulators are blamed for pressuring the banks to exit these types of relationships due to the reputational risk and potential for federal investigation. According to the Washington Post, the Department of Justice has launched several criminal and civil investigations as well as issued more than 50 subpoenas to banks and payment processors. The public outcry and response to this pressure have been overwhelming.
The Independent Community Bankers of America (ICBA) drafted a letter earlier this year asking for a suspension of Operation Choke Point and suggested targeting businesses actually breaking the law rather than the banks supplying payment services.
According to Bloomberg, the Community Financial Services Association, the main payday lending trade group, filed a lawsuit on June 5, 2014.
How Operation Choke Point has been carried out sounds all too familiar and similar to what we have seen with the Money Service Businesses. The ripple effect of increased regulatory expectations and scrutiny of banks doing business with money service businesses that result in account closures is eerily similar.
We have not previously seen a situation when a regulator mandates an account closure. Even more effective than a subpoena and potential for federal investigation are enforcement actions outlining what it will take to stay in compliance. Bankers are prepared to fight for their customers as every core deposit counts. That being said, we have seen banks responding to pressure through Operation Choke Point with decisions to exit relationships and certain industries after considering the level of the increased compliance and reputational risk, and not seeing any other option.
There are risks that clearly are too high to be undertaken by a financial institution without a commensurate compliance program and resources; however, providing financial services to high-risk and legal businesses may not be one of them.
Banks are expected to assess and manage the level of the risk, to know the customer and the customer’s customers and to monitor them regularly. Most automated BSA compliance software and even manually created risk assessments include the nature of the business as one of the risk elements. Some institutions assign a rating based on the North American Industry Classification System (NAICS) and others use their own definition. It is suspected that industries targeted by Operation Choke Point have most likely been already recognized and rated as higher risk by the institutions themselves.
What has changed with the implementation of Operation Choke Point is the level of reputational risk of the banks caught doing business with entities the federal government is targeting. One way to deal with the risk to exit the whole industry, the other is to show the regulators that the levels of risk are understood, documented, accepted, and managed by the institution.
The overwhelming negative response did not fall on deaf ears. On May 30, 2014 the House approved fiscal year 2015 Commerce, Justice, Science Appropriations bill removing Operation Choke Point funding. While Operation Choke Point will not go on, the underlying expectation of the banks cooperation in identifying, monitoring and reporting high-risk businesses will.
Here is an example of what we may see going forward:
The ICBA published the State of New York Department of Financial Services (“DFS”) June 16, 2014 press release under the Operation Choke Point title. The abbreviated story is that Bank of America is the first financial institution to agree to use a database of companies that have been subject to actions on evidence of illegal payday lending. It is important to note that payday lending is illegal in New York.
Bank of America will use the database to enhance its due diligence on customers. Bank of America will identify payday lenders engaged in illegal payday loan transactions with its consumer account holders in New York and contact lenders’ banks to notify them that the transactions may be illegal. Bank of America will also notify the DFS about payday lending activities by lenders listed in the database including identifying the lenders.
In the press release the Bank of America stopped short from committing to closing accounts and exiting relationships. Banks will be expected to cooperate and report on business identified as illegal.
Regulatory expectations will continue to rise and it is up to banks to respond with adequate compliance management systems, resources, including knowledgeable Compliance and BSA Officers, and leveraged monitoring technologies and automated processes.
This article was written by Petra Hrachova.