How Far Will RICO Probes of Online Lenders Go?

The government's recent efforts to rein in consumer fraud are well-known. In a significant development, however, the U.S. Department of Justice is now applying a statute more commonly known in organized crime cases - the Racketeer Influenced Corrupt Organization Act - to the conduct of online payday lenders.

RICO prohibits the "collection of unlawful debt," but its use in dealing with the online lending industry charts new ground. Prosecutors have cited the statute in three recent criminal cases, against Adrian Rubin, Scott Tucker and Charles Hallinan. They must prove the defendants were in the business of lending money "at a [usurious] rate" that was at least twice the enforceable rate. The indictments allege the defendants' business models fit this description perfectly, and that they were able to operate mainly through "sham" arrangements with Indian tribes to claim sovereign immunity from state usury laws.

Whereas Rubin pleaded guilty to the charges against him and is awaiting sentencing, Tucker and Hallinan so far are contesting the allegations made in their indictments, which will present an early opportunity for observers to see the government's newest theory tested in the courts.

The government's extension of criminal RICO into online payday lending naturally leads to several related questions:

First, it is logical to wonder if the government might seek to extend the criminal statute into other online lending models. For example, could nonbank purchasers or assignees of consumer loans made over the Internet and funded by banks find themselves the subjects of a criminal RICO investigation if the loans exceeded the limits in state usury laws? The simple answer is possibly, as long as federal preemption laws and the "Valid-When-Made Doctrine" do not apply - issues that are currently before the United States Supreme Court. Indeed, civil RICO has already been extended to marketplace lending, where the statute has been cited in a class action suit against Lending Club that alleges usury violations.

Moreover, although less likely, it is conceivable that the investors, too, could be wrapped up in a RICO investigation if they are aware that the loans to be collected violate state usury laws, since RICO covers anyone who "directly or indirectly" participates in the conduct of the enterprise's affairs.

Second, the same questions apply equally to debt buyers who purchase delinquent loans originated by banks. Might they also be subject to a RICO investigation? Given the government's current approach, it certainly seems possible, depending on the outcome in the Supreme Court, if they seek to collect loans that violate various states' usury laws.

Third, the acquiring banks that have online payday and other lenders as customers, and others involved in the onboarding and monitoring of these merchants, should reconsider the adequacy of their BSA/AML controls and other methods to mitigate fraud and consumer protection risks. To be sure, prior guidance issued by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., along with the Federal Financial Institutions Examination Council's BSA/AML exam manual, discuss the need for financial institutions to understand the principal business activities, geographic location, and sales techniques of their merchant customers. This includes whether the merchants are operating legitimate businesses. Unfortunately, these requirements are written only in general terms and institutions looking for more specific advice may be frustrated.

For example, institutions may wonder to what extent they must investigate in which states their lender customers make loans, study the various APRs of such loans, and be certain that the recipients of each of the loans live in states that do not have bans or other rate caps. With respect to online payday lenders, they also may ask if they need to be certain that the stated relationships between payday lending businesses and tribes are more than sham arrangements. If so, how much diligence is sufficient? Are onsite visits or interviews with tribal members necessary? What about a review of contracts?

Lenders, financial institutions and others in the chain should pay close attention as RICO cases applying to online lenders progress through the courts. Independent of these cases, companies would be wise to review AML policies and procedures and other compliance and risk controls to see how they would deal with such issues given this new enforcement environment.

The government's decision to extend RICO's "collection of an unlawful debt" language to online payday lenders is a significant moment in federal law enforcement. If this new theory of law enforcement survives legal challenges, look for the government to continue using it in the online payday lending industry and potentially beyond.

Michael J. Bresnick, a former federal prosecutor and executive director of President Obama's Financial Fraud Enforcement Task Force at the U.S. Department of Justice, is currently chair of the financial services investigations and enforcement practice at Venable LLP in Washington, D.C. Evan Minsberg is an associate at Venable specializing in financial services regulation.