David Dayen: How Chase Bank Denying Services to a Condom Shop Is Really About Deregulating Payday Lending

By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen

Under the odd conventions of journalism, if someone else writes about a topic, especially if it resembles a “scoop,” nobody else can write about it. So if you go down the road for a week or so chasing a story and then you see it in your friendly neighborhood copy of The Huffington Post, you can basically stop chasing. Thanks for taking food out of my mouth, HuffPo!

But in this case, the complicated story in question warrants more attention, because it’s a really good lesson in how “lobbying” incorporates more than just paying rich people in suits to sweet-talk politicians and regulators. This is the darker side of lobbying, with the venerated “small business owners” everyone loves to deify caught in the crossfire.

The small business owner here is named Tiffany Gaines, and the business, Lovability Condoms. From HuffPo:

In mid-March, a division of JPMorgan Chase rejected an application to process payments for the fledgling New York City condom company Lovability, citing “reputational risk” associated with “adult” products. Ridicule and mockery predictably ensued. But Chase’s decision wasn’t an isolated corporate gaffe — it’s the latest, weirdest product to emerge from a subculture of startup lobbying groups, fringe tea party hyperventilists and small-time crooks who have spent months fighting a simple crackdown on money laundering.

That division of JPM, Chase Paymentech, is a third-party payment processor (TPPP). Banks use Automatic Clearing House (ACH) to clear payments, and the third-party payment processors prospect businesses that need payment services and connect them to the banks. In this case, Chase Paymentech happens to be owned by JPM, making this all the more confusing (they’re not a third party but the bank themselves). Back to Chase Paymentech, Tiffany Gaines and Lovability in a moment.

In a rare move designed to actually enforce the law, the Justice Department, along with banking regulators OCC and FDIC, have told banks to look critically at their relationships with TPPPS. Previously, TPPPs gave the banks plausible deniability to work with the scummiest of predatory operators. If those businesses ripped off consumers, the bank would simply say they didn’t know who the TPPP brought in, effectively transferring the reputational risk. Operation Chokepoint, the Justice Department initiative, held banks more responsible for these relationships.

DoJ, in a number of presentations with banks, told them to watch out for businesses likely to be committing fraud. In particular, they said to red-flag businesses that generate a lot of consumer complaints, or had high rates of unauthorized returns or charge-backs. This is already the responsibility of the banks, through the Suspicious Activity Reports they must file if they have knowledge that a client engaged in money laundering.

As I noted in a story for The Guardian last month, a major target of Operation Chokepoint is the payday lending industry. Recently, payday lending has migrated to the Internet. Online payday lenders set up shop in jurisdictions without much regulation – some on Indian reservations – and market shady loans nationwide, even in states that have interest rate caps or other restrictions. They can’t do this without access to the payment system – basically the payday lender gets access to the individual borrower’s bank account to debit fees, with the loans rolling over unless the borrower jumps through a bunch of hoops to pay them back. The banks pocket giant fees from the payday lenders, in exchange for ACH access.

Instead of chasing fly-by-night payday lenders that close one day and open under another name the next, DoJ decided to target banks for doing business with lawbreakers. Presumably, after enough of a crackdown, the market would work its magic, and banks would refuse to work with TPPPs that signed up online payday lenders, because of the risk of prosecution. Operation Chokepoint already nailed one bank, Four Oaks, for this kind of activity (the $1 million settlement was relatively significant for such a small bank). The fees banks get from TPPPs are lucrative, and DoJ’s action levels the playing field somewhat.

So back to Tiffany Gaines. Chase Paymentech denied payment service for her condom company, arguing “reputational risk.” It turns out that a new lobby shop called the Third Party Payment Processors Association basically threatened Capitol Hill lawmakers that they would do exactly this a couple weeks ago:

…banks, payment processing firms and a relatively new lobbying group called the Third Party Payment Processors Association have been going wild on Capitol Hill in recent months over a pretty conventional law enforcement effort with a salacious name: Operation Choke Point. The project attempts to curb money laundering by scrutinizing banks and payment processors that facilitate transactions with illegal businesses — petty fraudsters running payday lending scams, sham telemarketing operations and other shady groups […]

Democrats in Congress say the Third Party Payment Processors Association — a lobby group that formed last year in response to Operation Choke Point — has issued similar warnings in private meetings.

“They came in here and said, ‘How would you like it if we started cutting off things liberals like, like birth control?‘” says one House Democratic aide who met with the TPPPA in November.

“They can assign reputation risk based on their moral judgements, but everybody has different moral judgments,” TPPPA President Marsha Jones told HuffPost. “That’s the danger of it. One administration is polarized one way and the other another way. And we must remove morality out of payments because it’s dangerous.”

The TPPPA’s stance is ridiculous. Again, DoJ’s presentation was pretty clear: they’re looking for businesses that generated lots of consumer complaints, or that delivered high rates of unauthorized returns or charge-backs. A condom company selling a perfectly legal product had nothing to do with it.

I talked to Tiffany Gaines last Friday, and I asked her if Lovability generated a lot of customer complaints. “No, not at all,” she said. I asked if she got a lot of returns or charge-backs. “No, we’ve never even had one return,” she replied. Lovability should not have raised any red flags from Chase Paymentech, who Gaines wanted to work with because she had all her business accounts with Chase. The only thing close is a section that warns against “merchants selling questionable products and services.” But that really refers to whether the merchants follow the law, and needless to say, Gaines would not characterize condoms in an of themselves as questionable (nor would I).

So you see what probably happened here. The TPPPs are deliberately interpreting Operation Choke Point incredibly broadly, to generate complaints and embarrass the regulators into calling off the dogs. The smoking-gun proof of this comes from a conversation Gaines had with a marketing executive for Chase Paymentech, after she raised the initial stink and started a Change.org petition. Zach Carter of HuffPo heard about this too, but I’ll just relay what Gaines told me about this conversation:

The marketing executive for Chase Paymentech, she became aware of my situation through the media. She first said it was a bad judgment call on their part, and they would agree to process our payments. I said what would you do to make sure this doesn’t happen again. They said they would train their representatives to be more sensitive and inquisitive and understand the businesses they were dealing with more thoroughly.

I thought this was a wishy-washy attempt to get me to be quiet. I told her that my representative was very sensitive and inquisitive, but the power was not in her hands, it was in the hands of risk management department, who said my business fell into a prohibited category. I asked her, what are the prohibited categories? She said child pornography, fraud, this and that. I said condoms don’t fall into those categories, and also, isn’t there a gray area? You process payments for hotels, and they make a lot of their money off of adult movies.

So then she put the blame on the government. She said that Chase Bank is a federally regulated bank, and that they have to pay attention to federal regulations. Other pornography companies can use things that aren’t federally regulated.

The fact that the marketing exec cited federal regulations makes it clear that Chase Paymentech was “following” the guidance from DoJ and the banking regulators. Only they were following it to a ludicrous degree, I would argue deliberately, in order to make the regulatory effort look bad. And this is not a one-off effort. Since receiving notoriety for her story, Gaines has heard from other merchants, including one who produced condom cases, who experienced similar prejudices from the TPPPs.

This is not the typical lobbying we think about; it’s more like lobbying-through-threat: try to regulate us, and we’ll make life so miserable for innocent bystanders that you’ll drop the regulations. Here, the regulation in question simply makes banks responsible for noticing the fraud happening over the payment system they nominally control. They don’t want to do it, because they don’t want to lose lucrative business from predatory scam artists while they look the other way.

Clearly the TPPPA has some willing friends in the business press and in Congress pushing this narrative. American Banker ran this op-ed arguing that the Lovability situation shows “how bank regulators’ growing concern with reputational risk could easily spiral out of control.” As if it’s the regulators’ fault that financial institutions heard about banning scam artists and decided to ban condom shops instead.

The banks have also employed former FDIC Chair William Isaacs in their effort to lobby through the media.

If government bureaucrats, acting without statutory authority, can coerce banks into denying services to firms engaged in lawful behavior that the government does not like, where does it stop? The same slippery slope that the DOJ uses today to choke off payday lenders from banking services could tomorrow be used on convenience stores selling large sugary sodas, restaurants offering foods with high trans-fat content or family planning clinics performing abortions.

Bureaucrats aren’t going after firms engaged in lawful behavior, they’re going after petty fraud. That’s where it stops. The only ones creating a slippery slope are the financial institutions, to preserve their deregulated spaces where nobody looks out for consumers.

Congressional Republicans have been decrying the DoJ policy too – I heard a Senate hearing last week where every Republican gave almost the exact same talking point about banks “being strong-armed to cut off credit to legal businesses.” Sherrod Brown briefly replied that “the basis is safe and sound practices ultimately.” But try to do that and all of a sudden banks are denying services to condom companies, so we should just leave fraud well enough alone, I guess.

The obvious solution here would be additional regulatory guidance that reinforces the directive of stopping petty fraud and most assuredly not legislating morality. But from everything I’ve seen, that was already clear. As a DoJ spokesman told HuffPo, “The goal of these investigations is to hold financial institutions accountable for knowingly assisting fraudulent merchants that harm consumers or processing transactions while deliberately ignoring evidence that they are fraudulent.” That goal is apparently a bridge too far for the tender mercies of our financial establishment.

As for Tiffany Gaines, she told me that “I’ve taken on this role of activist that I wasn’t expecting to take on. I feel like I have a moral obligation to get to the bottom of this.”