The investigation's nickname is "Operation Choke Point," and that seems appropriate, because a noose appears to be tightening around the necks of banks that have business ties to online payday lenders.
A tentative $1.2 million settlement between the Department of Justice and a small North Carolina bank earlier this month sent a warning signal to at least 50 other companies the list includes both banks and third-party payment processors that have received subpoenas in the probe.
At the same time, the DOJ's investigators are feeling increased heat themselves, as congressional Republicans are questioning the motives behind the investigation.
In a recent letter to Attorney General Eric Holder, House Oversight Committee Chairman Darrell Issa requested documents from Justice and suggested that its probe is a veiled attempt to stamp out even legal online lending not a push to choke off fraudsters' access to the payments system, as investigators insist.
Issa's letter echoes some of the arguments made in recent months by online lenders, who have claimed that their industry is being unfairly targeted by the Justice Department, and bank examiners.
So the probe's stakes have gone up both for the banks being investigated and for those conducting the investigation.
The Justice Department's proposed settlement with Four Oaks Bank, an $809 million-asset institution with 14 locations in North Carolina, is believed to be the first such agreement in connection with Operation Choke Point.
The $1.2 million fine is a substantial sum for Four Oaks; during the first nine months of last year, it reported net income of just $52,000. On the other hand, the bank likely saw little choice in the matter.
In a recent court filing, Four Oaks states that a lengthy legal dispute would cause the bank "financial hardship," while the settlement will "improve the bank's prospects of raising capital."
Many of the banks that have received subpoenas in Operation Choke Point are also small institutions, sources have said. Small banks typically lack the legal firepower to go toe-to-toe with federal prosecutors.
"If there's any vulnerability on the merits, the DOJ has the power to extract settlements from almost any bank they deal with," says one industry lawyer who asked not to be identified. "It's hard to fight them."
In connection with the proposed Four Oaks settlement, the Justice Department filed a 39-page complaint that paints a portrait of a bank willfully ignoring violations of the law in order to preserve a lucrative revenue stream.
The case revolves around Four Oaks' relationship with an unnamed Texas-based third-party payment processor, which stood between the bank and more than 20 online lenders. A July 2009 agreement with that payment processor has generated more than $850,000 in gross fees for Four Oaks, according to the complaint.
The court document states that about 97% of the merchants that used the third-party payment processor, and by extension Four Oaks, to access the payments system, and to make withdrawals from customers' bank accounts, were Internet payday lenders.
Various online payday lenders misled customers and manipulated repayment withdrawals, leading to unexpected charges, according to the DOJ's complaint. "Through this process of misleading and deceptive Internet payday lending, many of the borrowers are sucked into a vortex of debt and their banks accounts are debited until they are bled dry," the document states.
The complaint also alleges that these online lenders, which are unnamed, operate in violation of state laws that establish interest-rate caps and require lenders to get licenses.
More problematic for Four Oaks are allegations that the bank ignored fraud complaints from the online lenders' customers, and also ignored warnings about high rates of reported unauthorized debits from customer bank accounts.
In one email exchange, a Four Oaks employee who was researching one of the online payday lenders wrote, "I cannot approve this one based on all of the negative news. I think we would end up wishing we had let this one go."
But that employee was overruled by a senior bank official, who wrote: "We already have the relationship, so we already have the risk. Plus to deny based on consumer complaints, I think we'd need to look at shutting down the current business, for the same reason."
Four Oaks stated in a Jan. 9 news release that it does not admit any of the facts alleged in the complaint. A company spokesman did not return a call seeking additional comment.
As part of the settlement, Four Oaks acceded to tight restrictions on its ability to do business with Internet consumer lenders and those companies' payment processors.
For example, if a particular online lender has seen more than 0.5% of its electronic customer debits returned because they were unauthorized, Four Oaks is permanently barred from providing banking services to the company.
Four Oaks is also barred from allowing the use of remotely created checks a device sometimes used to collect overdue loans in connection with online payday lending and certain other businesses.
Sources close to the online payday lending industry declined to speak on the record about the Four Oaks settlement. But some acknowledged that the proposed agreement, because it establishes a template, could lead to more settlements.
Marsha Jones, director of the Third Party Payment Processors Association, said that assuming the DOJ's allegations are true, Four Oaks did not have an adequate compliance management system.
"We'd all like to have an opportunity to sit down and work through what the concerns of the Justice Department and the regulators are," she said. "I would like to see an opportunity for the Third Party Payment Processors Association to be able to support some of these financial institutions and their processors to become compliant."
Issa's letter, which was sent one day before the Four Oaks settlement was announced, is forcing the Justice Department play defense at the same time it is going after banks.
"The Department has consistently stated that its goal is to combat mass-market consumer fraud. However, there is ample evidence that the true target of Operation Choke Point is the online lending industry, not actual fraudsters," Issa, R-Calif., and Rep. Jim Jordan, R-Ohio, wrote in the letter.
The letter accuses the Justice Department of unfairly punishing legitimate businesses by focusing on an access point to the financial system that can be used by good and bad actors alike. It asks Justice to turn over a trove of relevant documents dating back three years.
A Justice Department spokesman said in an email: "We're reviewing the letter and will respond to the committee in the near future."
Since Issa's Jan. 8 letter was sent, consumer advocates have rallied in defense of the investigation.
Last week the National Consumer Law Center sent Attorney General Holder a letter of support, noting that the Four Oaks case concerned not only online payday lending, but also an alleged Ponzi scheme and other illegal transactions.
"It is entirely appropriate for DOJ to target banks that flagrantly ignore their legal obligations and turn a blind eye to fraud," Lauren Saunders, managing attorney at the National Consumer Law Center, wrote.
"Efforts to combat terrorism, drug cartels and other threats to American society also depend on banks' complying with their legal obligations to know their customers and their customers' customers."