Over the past year, the Federal Trade Commission (FTC) and the Federal Deposit Insurance Corporation (FDIC) have issued guidance to financial institutions and payment processors regarding risks associated with merchant banking (see Pepper’s February 3, 2012 Financial Services Alert, “FDIC Focuses on Payment Processing Programs at Community Banks: Is Your Compliance Sufficiently Robust?”).

It has been reported publicly that the FDIC has brought enforcement actions that have resulted in formal cease and desist orders and monetary penalties against insured depository institutions, and the FTC has actively sought injunctions against participants in allegedly unlawful payment processing activities.

Recently, a federal judge has found that a plaintiffs’ class action lawsuit has sufficiently pled facts to state a claim against Zions First National Bank (Zions) and several payment processors for private racketeering violations in connection with their relationships with allegedly fraudulent telemarketing schemes. (See Reyes v. Zions First National Bank, et.al. Civil Action No. 10-345, 2012 BL70261 (E.D. PA. Mar 21, 2012)). The allegation supporting the RICO claim included that Zions and the payment processors “... served independent and crucial roles in conducting an enterprise with the common purpose of earning fees for facilitating fraudulent telemarketing schemes ... and ... pleads facts showing that Zions Defendants ... were aware of several blatant indications of fraud, including ... staggeringly high rates of ACH returns, and in particular, rates of return for lack of authorization ... Reyes also sufficiently pleads a pattern of such racketeering activity by the Zions Defendants.”

The court also looked at ongoing government enforcement activity, particularly one by the Iowa attorney general against one of the defendants for having “... assisted fraudulent telemarketers by performing essentially the same function ... as are alleged to have been performed in this case.”

A violation of a RICO statute can result in treble damages and attorneys’ fees, and the reputational risk associated with being a defendant in such a case is significant.

A convergence of government enforcement actions seeking to terminate conduct and fine the enterprise and those complicit individuals, with private civil litigation seeking damages and attorneys’ fees creates serious legal, reputational and compliance risks if consumers are harmed. “Financial institutions that fail to adequately manage these [merchant banking, payment processing] relationships may be viewed as facilitating a payment processor’s or merchant client’s fraudulent or unlawful activity, and thus may be liable for such acts or practices.” (See FIL-3-2012). The key allegation in the Zions case is that the Zions Defendants provided critical banking services to enable telemarketing criminals to prey on consumers.

The government expects those it regulates to adequately oversee all transactions and activities it processes and to appropriately manage and mitigate operational risks, Bank Secrecy Act (BSA) compliance, fraud, and consumer protection risks. (See FIL-3-2012). Often banks that have been subject to enforcement actions face significant additional risks of class actions. Indeed, in February 2011, the Office of the Comptroller of the Currency imposed an $8 million penalty against Zions for having insufficiently robust BSA compliance procedures for transactions in 2006 through 2008. Federal regulators usually count on BSA systems to detect and stop fraudulent telemarketers from using the banking system. (See http://www.occ.gov/news-issuances/news-releases/2011/nr-occ-2011-16a.pdf.)