Banks have long argued that processing debit card transactions by starting with the largest dollar balances and working their way to the smallest benefited customers. Here's an alternate explanation of what might have motivated them: "Multiple Millions $$$$$$$$$$$$$$$$$$$$."
That was the pitch a popular vendor of "high-to-low" debit transaction processing software delivered to Union Bank of California, a unit of Mitsubishi UFJ Financial Group, according to documents recently unsealed in a consolidated federal class action.
CAST Management Consultants promised that by processing customers' daily checking and debit transactions based on the highest to the lowest dollar values, instead of in chronological order, Union Bank could drastically increase how many "insufficient funds" fees clients paid. Union Bank signed up, according to an amended class action complaint pending in U.S. District Court for the Southern District of Florida.
The Union Bank case is one of more than 30 related suits pending before U.S. District Judge Lawrence King and the first in which previously confidential documents have been unsealed. Consolidated by the court in 2009, the now unified multidistrict class action alleges that large banks manipulated the order in which they processed debit card transactions to checking accounts to stick customers with higher overdraft fees. Specifically, it alleges that banks shifted to high-to-low processing to maximize the number of overdraft fees charged after customers' checking account balances dipped below zero. Such practices were often hidden from bank customers even as they were used to extract illegal fees, the class action alleges.
The industry has contended that high-to-low processing was legitimate and in fact in demand among customers who wanted their largest bills to be paid first.
The difference of views has led to numerous cases charging leading banks with wrongful behavior. Among them: Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and Fifth Third Bank. Some of the suits have been settled out-of-court. In other cases banks appear to have a solid shot at getting claims transferred to industry arbitration panels, where they are likely to result in a more favorable outcome for defendants, as previously reported in American Banker.
In Hassler v. Sovereign Bank, a judge in the U.S. District Court of New Jersey dismissed a high-to-low case because the judge found that the bank's processing method had been adequately disclosed.
Whatever the final outcome of the Union Bank case, it could prove highly embarrassing to the commercial banks by showing how they aggressively adopted recommendations of lavishly paid consultants, even as they downplayed the ethical, legal and reputational risks.
"They're all similar," says Aaron Podhurst, an attorney on the plaintiffs' executive committee in the consolidated Florida class action, of the lawsuits. Banks "were warned in-house that this is dangerous, get rid of this, not a good idea. And they didn't heed that."
Documents filed in the Union Bank case appear to paint a picture of an institution focused on maximizing fee revenue by using CAST's technology while dismissing employee concerns that resequencing payments was unfair and possibly illegal. One bank employee argued high-to-low processing was harmful to "Poor but Honest" customers, according to an email sent from a colleague and cited in the amended complaint.
Bank documents turned over to plaintiff attorneys during discovery indicate Union Bank agreed that CAST would receive 20% of any extra overdraft charges generated under its high-to-low system. Union Bank employees also discussed how to hide the bank's policy from customers, even as it was costing them tens of millions of dollars, internal emails show.
"By design, the details of what happens inside the bank when an overdraft occurs were never intended to be communicated to the public," a Union Bank employee wrote to a colleague in an email cited in the suit.
Union Bank said its overdraft policies were in line with those of its peers in a written statement to American Banker. Those policies "reflect our customers' preferences, and are lawful," a bank spokeswoman wrote. CAST, which is based in Los Angeles, did not respond to repeated requests for comment.
There is a strong case to be made for processing checks — as opposed to debit card transactions — in descending order from those with the largest to the smallest balances, says industry researcher Mike Moebs. Large payments tend to be the most important to customers, and beginning with them makes it more likely that they will be paid in the event that a customer does not have enough money to immediately cover all charges.
In contrast to check processing, however, debit card charges are what are called "must pay" transactions, meaning the bank is committed to covering all bills in the system. Under these terms, there is no benefit to customers in having their largest transactions processed first.
Union Bank reversed its high-to-low overdraft policy last year. It now posts transactions from the lowest-to-highest values.
Some Union Bank records do show employees arguing that high-to-low processing would meet an unspecified "customer demand." However, executives raised objections on fairness grounds, while the employees implementing the system appear to have feared an adverse customer reaction.
"Posting large items first has been done before and is very painful to customers," wrote Charlie Pedersen, who oversaw the bank's processing operations, shortly after the high-to-low processing policy was proposed. "So go forward into the night, but keep the headlights on."
Pedersen, who has since retired, did not return a call from American Banker.
"We should … burn all our documentation that [says the only purpose of reordering payment] posting sequence = more fees," an employee wrote in an exchange cited by class action attorneys.
Union Bank's venture into high-to-low processing began in 2002, when it retained CAST, a consulting firm headed by Steve McCollum, a former Citigroup banker. CAST promotes itself on its website as an expert in "revenue optimization" based on a "database of proven revenue enhancement practices." Its clients include Citibank, Wells Fargo, U.S. Bank and more than a dozen large regional banks.
Union Bank brought in CAST with a mandate to leave "no stone unturned, particularly in the fee-income area," according to a document cited in an amended complaint but not yet available through Federal court records.
CAST turned to overdraft processing. The tweak required is conceptually simple: By deducting a customer's largest payments first, the bank increases the likelihood that his or her account will incur multiple overdrafts.
The order in which the transactions are processed can have a big influence on fees charged. Assume, for example, that a customer has $100 in his checking account and engages in four debit card transactions over the course of a day — three for $10 and a final one for $110. Processing the small transactions first will result in a single overdraft charge, while putting through the large transaction first will result in four overdraft fees.
A system of putting through the transactions in whatever order maximized fees would in the first year boost Union Bank's overdraft revenue by $18 million, or nearly 25%, CAST estimated. CAST also recommended raising the charge per overdraft and sought one-fifth of all additional revenue.
Some Union Bank executives balked. "Well, as a UBOC shareholder [and a consumer] I would STRONGLY disagree with the high-to-low approach," William Christensen, the bank's executive vice president for item processing, wrote to colleagues in a 2003 email released by the court. "I don't believe that UBOC [Union Bank] has ever done this before … I don't think the bank ought to do anything that encourages a class action lawsuit right now."
Email messages indicate that other executives also opposed a switch to high-to-low debit card processing, and the idea appears to have languished for a while. But in May of 2003, with Union Bank apparently scrounging to make its numbers, its chief marketing officer, Gretta Ryan, raised high-to-low again.
"CAST seems to believe it had seven-figure opportunities and given we are drifting way behind budget I'd like to see if this was ever implemented," Ryan said in a May 21, 2003 email. In a followup email a month later, she acknowleged her colleagues' distaste for high to low but advocated moving forward anyway. "We are not taking any of these concerns lightly but obviously with $1.0mm a month at stake we want to try to work them through to … let the risks be weighted against the rewards," Ryan wrote in an email to colleagues that is disclosed in the Florida class action.
Ryan is still with the bank but did not respond to an email seeking comment. She also appears to have felt pressure to brush aside employees' qualms about highest-to-lowest processing from the fact CAST was portraying bank competitors as forging ahead.
"Everyday [CAST employees] email me with another Bank's practices," she wrote. "5th 3rd [Fifth Third Bank] switched to high to low posting order and according to CAST, they have never looked back."
Neither would Union Bank. In the summer of 2003, it established a "High to Low Implementation Team" in cooperation with CAST. In the first year, overdraft revenue jumped far more than expected — by $33 million to a total of $125 million.
Customer complaints finally led 2009 to suggestions by employees that Union Bank reverse its high-to-low processing.
"There is considerable pain around overdrafts in general," Chief Administrative Officer Linda Odenath wrote to colleagues in 2009, citing high-to-low processing as problematic. Once a customer is overdrafted "it is hard to catch up," she added.
Despite such concerns, Union Bank did not reverse its policy on debit card transactions for another year, by which time it was embroiled in the multidistrict litigation.
"While I have always had a philosophical problem with paying high to low, I suspect the loss of income would be significant if we were to change at this time," senior vice president Mark Woods wrote to colleagues.
Woods also did not respond to a request seeking comment.