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.
All of this came down on Tiffany Gaines' new sex-positive condom startup, Lovability.
"My mouth just dropped open," Gaines told The Huffington Post, describing the moment she received an email saying Chase wouldn't accept her business. "It really points out the problem that my company is trying to solve … this cultural perception that it's naughty, that it's something that young people should be ashamed to be associated with."
Chase declined to comment for this story. But according to Gaines, after a few days of bad press, someone from the company's marketing department said that the firm would reverse its decision. When she asked for an explanation, Gaines said the bank initially tried to pin the misfire on a bad sales rep, but eventually got around to blaming the government.
"She told me there were federal regulations on what kinds of businesses they could work with," Gaines said. "I challenged her on what is in the prohibited area. And she said pornography and this and that."
There are no government rules that require major corporations to annoy birth control startups for a few days before agreeing to do business with them. In fact, there are no federal regulations requiring payment processors to reject sex toy shops, porn or any other legal businesses connected to sex.
But 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.
It's Money Laundering 101, but the program's detractors have portrayed it as a vicious government effort to dictate what kinds of companies banks can do business with.
The most extreme element of the movement comes from the anonymous, conspiratorial website stopthechoke.com, a site that features an image of President Barack Obama as Godzilla "destroying America" and warns that guns, ammunition, pharmaceuticals and other whole industries may soon be eliminated. The site has developed a bit of a following on Facebook, with more than 37,000 likes.
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."
What's astounding about the lobbying blitz isn't that major companies are complaining about government regulations -- rather, it's that this is a response to a simple crackdown on straightforward fraud. Early this year, House Oversight Committee Chairman Darrell Issa (R-Calif.) suggested in a letter to Attorney General Eric Holder that the Department of Justice is abusing the fraud investigation in an effort to harass and intimidate all payday lenders.
"We support the fight against fraud because it only hurts the processors, too," Jones said. "But the tactics the government is using right now is like bombing a neighborhood to catch a drug dealer."
There is no evidence that Chase declined Lovability's application to send a political message. But the episode highlights just how extreme the private sector reaction has been to a very basic law enforcement effort. Even for Washington, this is all a bit much.
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Moving money for criminals is called money laundering, and it's illegal. Since 1970, banks have been required to monitor their clients' transactions to ensure they don't funnel funds for drug dealers, gun runners, or any other illegal outfit. But some banks have been accused of looking the other way in the name of profit. In 2011, Wachovia settled federal charges that it laundered over $378 billion from Mexican drug cartels. The bank paid a fine, and the Department of Justice ultimately decided not to prosecute any Wachovia employees (although it has done a bang-up job jailing rank-and-file workers at medical marijuana shops that are legal under California state law).
There's a similar lowest-common-denominator enforcement strategy at play in the hubbub over Lovability and payday lending. In late 2009, Obama established the Financial Fraud Enforcement Task Force -- a coalition of federal agencies committed to combating bad things that people do with money. Bank reform watchdogs had hoped that the group would prosecute Wall Street malfeasance from the 2008 financial crash.
They have been disappointed. Instead, the Obama administration has focused on relatively penny-ante frauds, although "focused" may be a generous term. An Inspector General for DOJ recently concluded that the agency had been doctoring its mortgage fraud investigation numbers to boost its PR image.
One strategy from the FFETF that hasn't become a punchline is Operation Choke Point. The idea is to prevent illegal funds from breaking into the banking system through payment processing companies. When consumers get duped by a bogus sweepstake or a shady porn site, they will sometimes contest the transaction and get their money returned. When payment processors show an unusually high rate of returned funds, DOJ subpoenas records to review whether the banks know they are working with scammers. It's not quite the least that the government can do to fight financial fraud, but it's pretty close.
Nevertheless, it has sparked an aggressive backlash. Most of the activity from DOJ so far has focused on payday lenders that break the law, prompting Issa's particular grievance about Obama trying to wipe out the payday lending business.
Banks can process payments on their own, but they sometimes hire third-party firms to outsource the gruntwork of gathering and maintaining clients, or to distance themselves from risks. A third-party payment processor generally foots the bill if a client can't pay up, for instance.
Usually everything is above-board. But the relationship also provides a reputational buffer when working with unsavory characters. A bank can still profit from a dirtbag client without having to fess up to working with a lowlife. If a shady operation gets busted, the bank can pin the blame on it's third-party payment processor in the court of public opinion. That's what Chase meant by "reputational risk," when it rejected Lovability. Chase Paymentech is basically a third-party payment processor that happens to be owned by JPMorgan. The company declined to comment on whether it is a member of the TPPPA, and the lobbying organization does not disclose its membership.
Under Operation Choke Point, the FDIC has warned banks against working with firms that defraud people. Working with fraudsters creates two liabilities. Under money laundering law, the bank can be liable for losses that consumers take on petty scams. And the bank can also look like a bunch of jerks who help rip off consumers -- reputation risk that can curb profitability and contribute to financial strain in times of trouble.
Obama didn't invent this law enforcement focus on payment processors to crush the free market. In the George W. Bush years, Wachovia paid almost $150 million to resolve charges that it allowed a third-party payment processor to funnel money from telemarketer scammers into the bank.
The highest-profile fruit of Operation Choke Point thus far was borne in January, when Four Oaks Bank agreed to pay $1.2 million to settle civil charges that it used shady payment processors to work with a pyramid scheme called ZeekRewards and payday lenders that had been charging illegal fees.
Four Oaks Bank is tiny. With $865 million in assets, the bank is well below 1 percent the size of the $2.4 trillion JPMorgan Chase.
Senate Democrats have been pleased with the consumer protection effort from DOJ. In February, more than a dozen of them sent a letter to the agency encouraging it to keep up its efforts, despite Issa's saber-rattling on behalf of the payday loan industry. The list of signatures includes bank reform advocates Sens. Elizabeth Warren (D-Mass.) and Jeff Merkley (D-Ore.) alongside Sen. Dick Durbin (D-Ill.), the third-highest ranking Democrat in the Senate.
So where does all the crushing of private business come in? It doesn't, really. But in January 2012, the FDIC issued guidance -- not even a formal regulation -- that banks be careful about working with third-party payment processors that process a lot of fraudulent transactions. The FDIC also said to be particularly careful with some industries where fraud is especially common. In a footnote, they listed a few:
Examples of telemarketing, online businesses, and other merchants that may have a higher incidence of consumer fraud or potentially illegal activities or may otherwise pose elevated risk include credit repair services, debt consolidation and forgiveness programs, online gambling-related operations, government grant or will-writing kits, payday or subprime loans, pornography, online tobacco or firearms sales, pharmaceutical sales, sweepstakes, and magazine subscriptions. This list is not all-inclusive.
The guidance was updated in September 2013, but nothing bans or even officially punishes banks for even indirectly working with companies in any of these industries.
In short, Chase relied on a footnote to two-year-old regulatory guidance on being careful about fraud to reject Lovability's application. Neither the FDIC nor DOJ care a whit about banks doing business with condom companies. The FDIC told HuffPost that its guidance speaks for itself, while DOJ emphasized that it's just trying to investigate fraud.
"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," a DOJ spokesperson told HuffPost. "I want reiterate that our series of investigations is addressing fraud, not 'third-parties involved with payday lending.'"
Lovability's online store is up and running. For the time being, Gaines is using PayPal instead of Chase.
UPDATE: Chase passed along this statement after the article was published:
We’ve reached out to Ms. Gaines, apologized for the misinformation that we originally provided to her and offered to process payments for her business. As you know, we process payments for a wide variety of merchants, including grocers and drug stores, that sell similar products.
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