Don't whitewash the history of bank regulators' abusive practices

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As part of a bipartisan effort to enable cannabis firms to access the banking system, Congress is considering limiting regulators' power to pressure banks to cut off customers who, while engaged in legal practices, are considered unsavory or unpopular. The use of this concept, called reputation risk, has been abused by regulators several times in the past. That they have pressed financial institutions to de-bank legal-but-disfavored clients, with little to no independent legal justification or public safety value, is quite clear. Unfortunately, this good-faith effort by Congress is spawning an attempt to airbrush real cases of regulatory abuse out of history.

The hinge of this effort is what's come to be known as "Choke Point" — a catchall for abusive efforts by regulators to choke off disfavored industries' access to banking services. Just as all kinds of facial tissues are popularly called Kleenex, the term is based on a more specific one: the Justice Department's "Operation Choke Point." This was an effort by law enforcement, a decade ago, to aggressively investigate banks that offered services to legal businesses deemed to present a high risk of money laundering.

The DOJ'S Operation Choke Point did not, so far as we know, significantly involve bank regulators abusing their power. However, this doesn't mean that such abuses haven't happened. Far from it. In fact, the FDIC engaged in abusive behavior before and roughly contemporaneously with the DOJ's effort, which has created some confusion about the extent of the actual Operation Choke Point.

This ambiguity is being exploited by groups opposing holding regulators accountable by whitewashing history. Somehow, we're led to believe, past abuses were imaginary and greater accountability would prevent regulators from warning banks about fraudulent transactions and accounts.

For example, consider this statement by a representative of the National Consumer Law Center (NCLC): "Operation Choke Point had a sexy name and it gave the right wing all sorts of fodder for 'the government's coming after your guns.' None of that was ever true. Operation Choke Point ended years ago. [Reputation risk regulation] is not about going after legal businesses. It's about going after accounts being used unlawfully."

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In fact, in a letter recently submitted to the Senate Committee on Banking, Housing and Urban Affairs opposing a legislative fix, six organizations including NCLC, incorporated the misleading argument from an earlier comment. In the latter, the organizations focus exclusively on the DOJ's Operation Choke Point, which they paint as a justifiable exercise while failing to acknowledge the real, documented abuses that have become colloquially known as Choke Point.

The Inspector General of the FDIC disagreed with that sentiment, finding on at least two separate occasions that FDIC officials abused their power when, despite lacking a compelling legal reason to pressure banks to cut ties with lawful customers (primarily payday and refund anticipation loan lenders), they relied on reputation risk and other nebulous justifications to enforce their will.

The second example was particularly egregious and predates Choke Point by several years. In 2008, the FDIC, prompted by the National Consumer Law Center among others, decided that refund-anticipation loans (RALs) should be excluded from the banking system. They then had to decide why. When the argument that these loans were unsafe for the banks failed, because it wasn't true, the FDIC resorted to coercion to drive the banks out, using threats, changing supervisory rankings over the objection of the relevant bank examiners and refusing to allow a bank to pursue a line of business unless it exited RALs.

This abuse went largely unnoticed until it was discovered by the inspector general as part of an investigation into the FDIC's role in the officially titled Operation Choke Point and the contemporaneous abuse of its power against banks that served payday lenders. It was largely unknown because, as Prof. George Mocsary and I explain in an amicus brief asking the Supreme Court to take up a case involving the New York State financial regulator employing similar tactics, banks have strong incentives to avoid complaining.

Bank regulators have so much opaque power that they can punish banks in a host of informal ways, as the FDIC's abuses demonstrated. The FDIC didn't need to use a formal enforcement action, which could at least be eventually appealed before a neutral court. Instead, it just refused to let banks grow their business, marked them down on examinations on dubious grounds and subjected them and their partners to intentionally burdensome examinations.

This history must be acknowledged and taken seriously. Further, as University of Alabama Professor Julie Hill's work shows, limiting the power of regulators to rely on reputation risk will not prevent them from pursuing legitimate regulatory goals. Nor is it a panacea for eliminating the risk of regulatory misconduct. It is, however, an appropriate response to a real history of regulators abusing their power that no amount of gaslighting can erase.