Preventing Fraud on P2P Electronic Payment Networks: What Can We Learn From Montesquieu?
As a former staff member for the U.S. House Committee on Financial Services, I spent more than five years working to put together congressional hearings and helping prepare Members and other staff to ask questions of the invited witnesses. Now, as an outside observer, I take a particular interest in how hearings are structured; much information can be gleaned from the way witness panels are assembled, the partisan balance (or lack thereof), whether Members are well-informed on the subject matter of the hearing or are coming to the issue cold, whether questioning appears to have been contrived with witnesses in advance, the messaging themes used to frame the topic of discussion, etc. This is why I can’t help but notice when a particular hearing stands out as a clear outlier from standard practice. One such hearing occurred last week.
On Tuesday, May 21, the Permanent Subcommittee on Investigations of the Senate Homeland Security and Government Affairs Committee held a hearing billed as an inquiry into consumer-permissioned scams perpetrated by fraudsters who are successful in convincing consumers to send them money through various modes of payment including P2P platforms such as Zelle. One might wonder why P2P platforms other than Zelle were not included in the scope of the hearing, since such scams are also facilitated in part using those other platforms (and may occur at a higher rate). The only answer seems to be that Zelle is owned by banks, and this being an election year, banks are the softest target. It does not appear that Zelle or its owner banks were invited to testify, nor did any minority witness appear, so the hearing was apparently engineered to be a free-fire exercise for the “consumer advocate” witnesses invited by the majority.
Thus, the framing of the hearing was prejudicial out of the gate. A good-faith inquiry into the matter would have sought testimony from individuals in the best position to inform the Subcommittee’s members of basic facts regarding the operation of P2P networks, the relative incidence of scams and fraud in relation to other forms of financial fraud, and the anti-fraud mechanisms in place to deter fraudsters and educate users regarding the inherent risk in sending money to strangers. Unfortunately, as a consequence of decisions made regarding witness selection, many of these material facts were not explored during the hearing, which deprived the Members of a fuller understanding of the issue and awareness of the trade-offs of any policy options under consideration.
Notwithstanding these limitations, one material fact did become crystal clear at the hearing. That fact, which the majority admitted to in its hearing memo and which was discussed during witness questioning, is that consumer-permissioned scams of the type discussed at the hearing are not “unauthorized” electronic fund transfers as defined in the Electronic Fund Transfer Act (EFTA). Banks are not subject to the liability and error resolution provisions of the EFTA’s implementing regulation, known as Reg E, with respect to authorized transactions, even where such transactions may later be discovered by users to be fraudulently induced.
The hearing witnesses generally viewed this fact as a gap in the law. It appeared from discussion at the hearing that Zelle and banks that participate in the network have decided, as a matter of policy, to make users whole in certain circumstances, even though they are not required to do so by law. However, much of the thrust of the testimony adduced at the hearing was to criticize Zelle and participating banks for not automatically agreeing to cover 100% of all losses due to consumer-permissioned scams. The advisability of such a liability shift could be debated as a matter of policy, with the trade-offs understood and weighed. But the criticism directed toward the banks by some Members and some witnesses at the hearing amounted to blaming them for not going beyond the requirements of the law.
Enter Montesquieu. In his famous 1758 manuscript, The Spirit of the Laws, Montesquieu observed that to preserve liberty, “A government may be so constituted, as no man shall be compelled to do things to which the law does not oblige him, nor forced to abstain from things which the law permits.”
Montesquieu was of course a huge influence on the Founders of our nation, and his thinking regarding the separation of powers informed both the structure of our Madisonian Constitution and our foundational jurisprudence. For instance, Associate Justice Samuel Chase echoed Montesquieu in his 1798 U.S. Supreme Court opinion in Calder v. Bull: “The fundamental principle [of limited government] flows from the very nature of our free Republican governments, that no man should be compelled to do what the laws do not require, nor to refrain from acts which the laws permit.”
Montesquieu and Chase had it right. It is wrong (indeed, tyrannical) for the government to use its coercive power (in this case, to use congressional hearings) to browbeat private actors for simply following the law. That the framing of the hearing apparently drew no principled objection from any quarter is perhaps an alarming indication of the present tenor of debate in the halls of Congress. If senators, advocates, or any others believe the law is inadequate, the proper course of action is to use the legislative process to change the law.
Regrettably, the hearing missed an opportunity to build bipartisan support for addressing the root cause of the problem, which is perpetrators of financial fraud, who victimize both consumers and the P2P networks and participating financial institutions. Surely all sides could have agreed that there are meaningful policy steps that could be taken, such as enhancing criminal penalties for engaging in such scams, heightening DOJ’s prosecutorial focus on the issue, and beginning a robust CFPB consumer education effort.
Standing alone, the hearing could perhaps be dismissed as an outlier, but there are other indications that the government is preparing further coercive actions. Several senators have sent letters to Zelle’s operator and owner banks pressuring them to change their liability policies. One senator has also written to the CFPB urging it to take action, and it appears that the CFPB has obliged her. In recent SEC filings, some banks and P2P network operators disclosed that they are now under federal investigation, presumably by the CFPB. Since it is clear that the consumer-permissioned scams at issue are not covered by EFTA and Reg E (and the CFPB wisely abandoned prior reported plans to issue guidance contrary to that fact), it is not clear what (if any) legitimate purpose is served by the CFPB’s investigations.
The CFPB does have authority under the EFTA and its unfair, deceptive, or abusive acts or practices power to initiate a notice-and-comment rulemaking to address concerns it may have with the operation of P2P platforms, but it has not announced any such rulemaking. That would be the sole lawful means for the CFPB to alter the legal rights or obligations of market participants. Any public enforcement action resulting from the announced investigations (with the possible exception of an action limited solely to prospective injunctive relief), would herald an illegitimate return to the dark days when CFPB used “regulation by enforcement” as a coercive tactic to impose new obligations across an industry. Such an unjust action would likely provoke a righteous and forceful rebuke.
Let’s hope that cooler heads prevail. Consistent with the Constitution, Congress may enact legislation if it wishes. Consistent with existing statutes, the CFPB may promulgate regulations if it wishes. Coercive government tactics to smear American institutions for following the law should be resisted by all fair-minded citizens who value liberty. Instead, the full weight of the government should be trained on bringing culpable financial fraudsters to justice.
Note from the Editor: The Federalist Society takes no positions on particular legal and public policy matters. Any expressions of opinion are those of the author. We welcome responses to the views presented here. To join the debate, please email us at [email protected].