At least six federal agencies including the Justice and Treasury departments are coordinating a broad probe of online payday lenders that charge enormous interest and fees to low-income borrowers who need quick cash.
The Justice Department and the Consumer Financial Protection Bureau have sent civil subpoenas to dozens of financial companies, including the online lenders, many of which are located on Indian reservations to avoid complying with consumer protection laws. Also subpoenaed were banks and payment processors that do business with them, according to government and industry officials familiar with the probe. The people spoke on condition of anonymity because they were not authorized to discuss it.
The government is using a range of tools — anti-money laundering laws, routine oversight of banks’ books, subpoenas and state laws — that could snuff out an entire category of lenders who contend they are operating lawfully.
Among those involved: Justice’s Civil Division; the CFPB; the Federal Deposit Insurance Corp.; the Office of the Comptroller of the Currency; the Treasury’s Financial Crimes Enforcement Network; and attorneys general and financial regulators from several states.
The probe involves so many industry players that a half-dozen major law firms contacted by the Center for Public Integrity were unable to comment publicly because they are representing banks, lenders, payments companies, marketers and others that are wrapped up in the multi-pronged investigation.
The probe appears to be coordinated by the Financial Fraud Enforcement Task Force, a working group originally created by President Barack Obama to “investigate and prosecute significant financial crimes and other violations relating to the current financial crisis and economic recovery efforts.” The task force is led by the Justice Department and includes more than two dozen federal and state regulators and law enforcement entities.
Help "cut off" lenders
New York's top financial regulator on Tuesday ordered 35 online payday lenders to stop offering loans there that violate state laws capping annual interest rates at 16 percent. The state also sent letters to 117 banks, asking them to help “cut off” payday lenders from the global network used by banks to send money and collect payments.
A trade group representing online lenders suggested that New York’s move was misguided because “state laws are insufficient to govern the global nature of the Internet.”
“Rather than restricting consumer choice, state officials should be focused on finding a federal solution,” said Peter Barden, spokesman for the Online Lenders Alliance, in a statement.
Other states have prosecuted individual online lenders. California sanctioned at least ten online lenders starting last year. Minnesota’s attorney general has settled or won rulings against eight online payday lenders — most recently, an $8 million ruling in May against a company that operated without a state license. Last month, Virginia sued a different lender on similar grounds.
But New York’s was the first public action against such a wide range of players in the online payday lending industry. It follows a strategy outlined this spring in a speech by the head of the federal financial fraud task force: Cutting off lenders’ access to the banking system.
“If we can stop the scammers from accessing consumers’ bank accounts — then we can protect the consumers and starve the scammers,” said Michael Bresnick, the former federal prosecutor who directs the task force, in written remarks before the Exchequer Club of Washington, D.C. No longer focused only on companies with a clear connection to the financial crisis, the group wants to protect consumers from “mass marketing fraud schemes — including deceptive payday loans,” he said.
"Mass market fraudsters"
Referring to online payday lenders repeatedly as “mass market fraudsters,” Bresnick said the working group is focused on banks and payment processors that make it possible for online lenders to operate in states where their loans would be illegal. Bresnick lumped in online "deceptive payday loans" with more clear cut fraudulent industried like fake health care discount cards and phony government grants.
Payday lenders offer short-term loans of a few hundred dollars, mainly to poor, cash-strapped customers. Until about five years ago, they operated mainly out of storefronts that offered a range of money services to people who can’t or won’t use traditional banks. Consumer advocates have long called for stricter limits on the industry, which ensnares many borrowers in a cycle of borrowing anew to repay a previous loan and which can charge interest rates that exceed 1,000 percent.
A number of states, including New York, have tried to eliminate the practice by capping interest rates. Yet the industry has proven resilient. Storefront lenders exploit loopholes by tweaking the terms of their loans, reclassifying themselves as other types of companies and lobbying aggressively for friendly legislation, according to a report this week by ProPublica.
State efforts to regulate the loans have pushed many consumers online, where state laws have so far carried little weight. The Internet allows payday lenders to reach people living in cities or states where their products are illegal. Many companies in this growing market have evaded state and federal consumer protections by operating from Indian reservations. Tribal sovereignty puts them beyond the reach of U.S. regulators, they argue.
Tribal lenders were outraged by New York’s order to stop making loans there, saying it violates their constitutionally protected right to set and enforce their own regulations.
“Years of precedent set by the federal government are being thrown out the window by overzealous regulators looking to further oppress tribal nations and breach our sovereign rights,” said Barry Brandon, executive director of the Native American Financial Services Association, a trade group, in a statement. Brandon said the lending companies are wholly owned by the tribes and provide needed income for community development.
Yet some lenders that claim sanctuary on Native American land operate for the profit of outside businessmen who run them through a labyrinth of shell companies, according to an earlier investigation by the Center for Public Integrity. The Center found in 2011 that millionaire Scott Tucker operated and profited from payday businesses that were owned on paper by small Indian tribes — a practice known as “rent-a-tribe.” Tucker’s businesses are not affiliated with the NAFSA, the trade group representing tribal lenders.
The Federal Trade Commission sued a group of companies associated with Tucker in 2012 for misleading and charging undisclosed fees. The government won a major victory last month when a federal magistrate ruled that for-profit companies are not necessarily immune from federal consumer protection laws merely because they are affiliated with Indian tribes. The ruling by a magistrate must still be approved by a district court.
If that happens, the ruling “will have broad implications for all federal enforcers seeking to combat illegal payday lending practices,” said Jessica Rich, director of the FTC’s consumer protection bureau.
The court has not yet determined whether some of the lenders, officially chartered by Indian tribes, are for-profit corporations and therefore subject to FTC oversight.
The companies’ sense of security on Native American land has been rattled by other recent federal actions, including a round of civil subpoenas issued last year by the Consumer Financial Protection Bureau. The Justice Department later became involved in the investigation, according to industry members familiar with the probe who spoke on condition of anonymity to avoid fueling tension with federal authorities.
CFPB spokeswoman Moira Vahey said the agency does not comment on or confirm pending enforcement action. She said the agency is “looking at a wide range of issues involving payday lending and potential consumer harm, including the growing presence of online payday loans.”
“We will continue to oversee the market and if we find small dollar lenders engaged in unfair, deceptive, or abusive practices, the Bureau will hold those institutions accountable,” Vahey said in a written statement.
More than 50 subpoenaes
The Justice Department this spring subpoenaed more than 50 financial companies, mainly banks and the payment processors that connect consumers to online lenders and other companies that Justice thinks may be operating fraudulently. Banks that hold accounts for payment processors “aren’t always blind to the fraud,” said Bresnick, the fraud task force chief, in the March speech. He said they are ignoring red flags like large numbers of transactions by the processors being rejected by other banks.
These banks may be violating laws requiring them to report incidents of possible fraud to the Treasury Department — laws designed originally to prevent money laundering and later updated to combat financing of terrorist organizations. Those laws require them to know what kinds of businesses their depositors are operating or affiliated with — a duty known as "know your customer."
A spokeswoman for the Justice Department declined to comment.
The approach has proven effective. In November, a Delaware bank paid a $15 million penalty to settle charges that it worked with payment companies to make fraudulent withdrawals from consumers’ accounts. More than half of the debits were rejected by consumers and their banks. The overall rate reported by the Federal Reserve is about one-half of one percent. The bank lost its charter and was dissolved.
Regulators also are using bank oversight examinations to drive a wedge between banks and the online payday lenders they serve. They are warning banks during routine examinations to avoid the “reputational risk” of being tied publicly to an unpopular industry, whether by financing loans or processing payments for lenders.
The tactics are similar to those the government used in its successful campaign in 2011 to quash the online poker business, whose revenues had mushroomed to billions of dollars a year. The effort culminated in raids of the three biggest gambling sites and the arrests of their owners. The government shut down about 76 bank accounts in 14 countries and eliminated five domain names.
The companies were charged with bank fraud and money laundering. Before the raid, an agent who represents poker players told CNBC, the poker industry was aware only that authorities were investigating their relationships with payment processors.