Payday lenders hate it. Some Republicans on Capitol Hill malign it as a witch hunt against free enterprise.

But right now the biggest nemesis of "Operation Choke Point," the year-old Justice Department probe into scammers' use of the payments system, is a loose-cannon judge whose off-script questions have scrambled the carefully laid plans of prosecutors.

Caught in the middle is a small North Carolina bank that processed transactions on behalf of parties whom prosecutors consider unsavory. The outcome of the case could affect how dozens of targets of the probe, including other banks, will be treated.

The DOJ in early January reached a settlement with the $809 million-asset Four Oaks Bank in the department's first (and still only) lawsuit stemming from Operation Choke Point. Prosecutors accused the bank of turning a blind eye to a third-party relationship that enabled online payday lenders to bleed their customers dry.

At the same time the suit was brought, a tentative settlement was also filed in federal court in Raleigh, N.C. Under the deal, Four Oaks would pay a $1.2 million fine, accept tight restrictions on its ability to do business with online consumer lenders and make no admission of wrongdoing.

The deal is important for both sides.

Four Oaks is operating under an agreement with the Federal Reserve to maintain certain capital ratios, but the DOJ's investigation has scared off investors, the bank's lawyer has said in court. A settlement would lift the dark cloud that continues to hang over Four Oaks.

Meanwhile, the case could provide Justice a blueprint for future settlements with other banks. The department has sent more than 50 subpoenas to banks and payment processing firms as part of its investigation, according to a presentation by DOJ officials last fall.

Lawyers for both sides urged U.S. District Judge Terrence Boyle to approve the proposed settlement during a Jan. 9 court hearing, but Boyle refused to be rushed.

"I'm not going to sign something that I'm not comfortable with," he said, while raising questions about the terms of the proposed agreement.

Boyle has been sitting on the proposed settlement for the last two months, casting doubt on the deal's ultimate chances of being approved.

DOJ officials declined to comment. Jeffrey Knowles, a lawyer at Venable LLP who is representing Four Oaks Bank, said: "The bank cannot comment at this time until the judge has ruled on the proposed settlement."

DOJ's Balancing Act

Boyle's comments suggest that he disapproves of payday lending, notwithstanding his concerns about the tentative settlement. The judge referred to Internet payday lending as an "escalating crime or plague on the country, on the economy," according to the transcript of the Jan. 9 hearing.

DOJ officials are sensitive to any assertions that the agency is seeking to stamp out payday lending altogether, including the many companies that operate lawfully.

Some congressional Republicans, including House Oversight Committee Chairman Rep. Darrell Issa of California, have accused the DOJ of trying to eliminate the entire industry. Issa has requested documents about Operation Choke Point from the department.

Authorities are investigating more than payday lenders, including fake pharmacies and other fraud schemes, Joel Sweet, the Justice Department prosecutor in the courtroom, told Boyle. "Not everything is illicit, but where it is criminal, all of them are trying to find access to the U.S. banking system," Sweet said.

"We're not here telling people what you should do," added Sweet, whose temporary assignment with the DOJ in Washington recently ended, prompting his return to the U.S. attorney's office in Philadelphia. "If it's legal, it's your right to do it."

Offbeat Q&A

But Boyle showed little patience for drawing distinctions among the various categories of payday lenders, while also making skeptical comments about banks and the fairness of the settlement to consumer victims.

"Who owns payday lenders? I mean, is it the mob? Is it the Mexican cartel?" Boyle asked during the hearing. "Because if this was the '40s, I'd know who owned it. They were all on 'The Untouchables' or on the later 'Sopranos.'"

At another point during the same hearing, a lawyer for Four Oaks sought to explain that the bank tried in 2012 to end its relationship with an unnamed third-party payment processor that had numerous online payday lenders among its clients.

"And the payday lenders wouldn't let them?" the judge asked.

"Would not let them," responded Knowles, the bank's lawyer.

"Did they threaten their lives? Did they send some of the 'boys' over?" the judge responded. "They sent you the collected series of 'The Sopranos'?"

"Without characterizing it, let's say that the bank did not continue that relationship happily," Knowles said.

"I've never heard of a bank being the victim of extortion. Usually, the bank is the source of the extortion," Boyle shot back, according to the transcript.

"Let's indict these payday lenders here for their collusive crimes and extortion and racketeering. This is a great RICO case, isn't it?" the judge said to the Justice Department lawyer, referring to the Racketeer Influenced and Corrupt Organizations Act, which has often been used to prosecute mobsters.

Knowles explained during a second court hearing that the payment processing firm threatened to sue Four Oaks if it attempted to terminate the contract. "The contract, unfortunately, was not well drafted from the bank's perspective, and the payment processor itself made threats to sue the bank," Knowles said. "And in fact, those threats have continued to this day."

Sticking Point

During the second hearing, the judge's remarks were less colorful than they were in the earlier session, but he still sounded skeptical of the settlement's terms.

Boyle pressed a Justice Department lawyer on who would get the $1.2 million, assuming the settlement is approved. One million dollars would go to the U.S. Treasury, while the remaining $200,000 would go to a consumer protection fund that's administered by the U.S. Postal Inspection Service, according to court documents.

"None of the money will go to the victims who were individuals who may have lost money because of illegal activity?" Boyle asked.

"That's correct," replied Justice Department attorney Michael Blume, explaining that it would be difficult to identify who was defrauded and by how much. But the judge sounded unconvinced.

"I'm having trouble equitably seeing how the government taking the money from the bank helps the mom and pop who lost a thousand dollars, or lost $1,500 or $2,000," Boyle said.

Later in the same hearing, the judge asked Blume what the Justice Department would do if he refused to sign the consent order.

"Would you claim it was an abuse of discretion?" Boyle asked. "I'm just curious as to where we're going from here."

"Well, I can't speak to that, your honor," Blume responded. "We would explore our options."

Boyle was appointed to the federal bench in 1984 by President Ronald Reagan. Earlier in his career he spent time as an aide to then-GOP Sen. Jesse Helms of North Carolina.

In 1991, President George H.W. Bush nominated Boyle to a seat on the 4th U.S. Circuit Court of Appeals, but Senate Democrats blocked his confirmation as part of a broader partisan fight over judges.

Wider Impact?

Operation Choke Point got its name because federal prosecutors believe many fraudulent schemes depend on their ability to use the electronic payments system, and banks are in a position to choke off that access. (See related graphic.)

Earlier this month, PNC Financial (PNC) disclosed in a securities filing that it received a subpoena that is intended to determine whether the company may have facilitated fraud against consumers by third parties. But most of the banks that have received subpoenas as part of Operation Choke Point are smaller institutions, according to sources.

It is unclear whether the court proceedings in North Carolina will have a long-term impact on the DOJ's broader investigation. But they have added an element of unpredictability to the probe.

Near the end of the Jan. 9 court hearing, Judge Boyle asked a lawyer for Four Oaks: "Don't you wish I had just signed this thing yesterday, and it never saw the light of day — just sort of flew through the hallway?"

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