Operation Choke Point

Full Document Available in PDF

Can the government shut down legal but politically disfavored businesses? If an ongoing federal regulatory campaign continues, that may be precisely what happens. In recent months, a federal government regulatory initiative called Operation Choke Point has gained increased public and media attention.  Operation Choke Point is ostensibly a joint effort by various regulatory entities—the Department of Justice (DOJ), Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation (FDIC) most prominent among them—to reduce the chances of Americans falling victim to fraud in a variety of “high-risk” industries, predominantly payday lending. It uses existing regulatory powers to provide heightened supervision of banks that do business with the third party payment processors that provide payment services to these industries.

However, this seemingly laudable aim conceals a worrying reality. There is nothing illegal about most of these industries (at least not yet). But because they have been designated high-risk, banks are cutting off dealings with many processors and companies preemptively. As a result, many companies and individuals that have done nothing wrong have been frozen out of banking services.Without the links to banks, their financial lifeblood is choked off indeed.

Operation Choke Point echoes—and may in fact be modeled on—the federal government’s takedown of the otherwise legal American online poker industry in 2011. In that instance, regulators targeted payment processors that dealt with gambling businesses. As a result, banks became wary of doing business with those targeted payment processors. Finding their lifeblood cut off, some companies had no choice but to turn to less scrupulous processors or disguise transactions with them, leading to criminal liability—which in turn allows DOJ to close down the industry. Operation Choke Point appears to be heading down this road.

The development of Operation Choke Point appears to have begun with a 2011 FDIC circular that noted “an increase in the number of deposit relationships between financial institutions and third-party payment processors and a corresponding increase in the risks associated with these relationships,” including “greater strategic, credit, compliance, transaction, legal, and reputation risk.”

The circular also explained how certain industries appeared to be at greater risk of fraud than others, including: ammunition sales, cable box de-scramblers, coin dealers, credit card schemes, credit repair services, dating services, drug paraphernalia, escort services, firearms, fireworks, home-based charities,  lifetime guarantees, lifetime memberships, lottery sales, money transfer networks, online gambling, payday loans, pornography, tobacco, travel clubs, and many others.

The list of high-risk payment types was broadly drawn, with no indication as to the criteria inclusion on the list. Since then, a series of actions by the agencies participating in Operation Choke Point, led by the Department of Justice, have sought to crack down on these politically disfavored industries by choking off their access to the financial system.

The genesis of FDIC’s involvement in Choke Point has been FDIC’s concern about “reputational risk.” It is not a regulator’s—much less a criminal investigator’s—role to define reputational risk. Such a judgment is best left up to individual banks, which have a much better idea of the risks involved in their client relationships.  

While Operation Choke Point seems to have its origins in the worthy goal of tackling payment processor fraud, the Department of Justice’s application of the FDIC guidance has done nothing to protect consumers and has gone a long way to undermine the rule of law.

Operation Choke Point already has had a demonstrable chilling effect on commerce. Banks are already highly regulated. The burden of regulation is such that small and mid-size banks around the country are merging to deal with the compliance costs. Most such banks cannot afford the extra supervision that comes with a Choke Point subpoena. Thus, they often face no other choice but to drop payment processors and designated “high-risk” clients altogether.

Customers, meanwhile, are left with no recourse. Payday lenders’ customers are often “unbanked” and have no viable credit rating. They will therefore be tempted to seek out dubious or even illegal loan sources. Similarly, gun and ammunition purchases may increasingly be done off the books. The porn industry has only recently stepped out of the shadows, and it would be extremely negative for performers and customers to push it back into the shadows.

Operation Choke Point forces banks to do the investigators’ work for them by scrutinizing their customers’ business methods for potential criminal violations. While due diligence is to be expected from banks, criminal investigative duties are not. Shifting the costs onto supervised bodies is not an acceptable principle of governance. Businesses need to be allowed to make their own business decisions without the threat of being required by their regulators to do their job for them.

The FDIC’s list of high risk industries seems guided more by moral censure than by any real prospect of criminality. If “reputational risk” is a significant factor in designating an industry “high risk,” then it is not too difficult to imagine a future FDIC in more “conservative” times designating a whole different list of industries. For instance, otherwise legal marijuana sellers might make the list. So might abortion providers.

Policy makers should weigh Operation Choke Point’s few successes in stopping genuine fraudsters against its significant harm to customers of legal businesses who will become unable to access services they had hitherto enjoyed. In some cases, they may be pushed to seek the now-unobtainable service from illegal providers, with subsequent risks to their health, liberty, or both.

Congress should demand an immediate investigation by the Department of Justice’s Office of the Inspector General into the appropriateness of actions by officials at all levels relating to Operation Choke Point. Congress should also refuse to allow any funds to be used for Operation Choke Point until it has done everything in its power to curb its potential for abuse. Otherwise, lawmakers should choke off Choke Point.