Wells Fargo turned overdraft fees into a billion-dollar hustle.
Beginning in April 2001, when you made a string of purchases on your debit card, the bank would process the most expensive charges first in order to maximize the number of overdraft fees. Between 2005 and 2007, Wells Fargo made $1.4 billion from this.
The widely used banking practice was so shady that the Obama administration implemented new rules requiring banks to ask customers' permission before providing them with automatic overdraft protection. And some of Wells Fargo's California customers filed suit.
But while the overdraft fee hustle might be shady, it is not illegal, the Ninth U.S. Circuit Court of Appeals ruled on Wednesday.
"A national bank's decision to post payments to checking accounts in a particular order is a federally authorized pricing decision," Judge Margaret McKeown wrote in the 3-0 decision.
The way banks explain it, overdraft protection benefits the customer by preventing those embarrassing "I'm sorry, your card has been declined" moments.
"When there are insufficient funds in your account to cover a check, withdrawal, or automatic payment that you have authorized, and you have Overdraft Protection, we pay the Item and charge you an overdraft protection transfer/advance fee," Wells Fargo states on its website.
Before April 2001, the San Francisco-based bank processed payments from lowest to highest dollar amount. This minimized the number of overdraft fees a customer would face. Then the bank switched it up.
As the appeals court explained in its ruling:
[C]onsider a customer with $100 in his account who uses his debit-card to buy ten small items totaling $99, followed by one large item for $100, all of which are presented to the bank for payment on the same day. Under chronological posting or low-to-high posting, only one overdraft would occur because the ten small items totaling $99 would post first, leaving $1 in the account. The $100 charge would then post, causing the sole overdraft. Using high-to-low sequencing, however, these purchases would lead to ten overdraft events because the largest item, $100, would be posted first -- depleting the entire account balance -- followed by the ten transactions totaling $99. Overdraft fees are based on the number of withdrawals that exceed the balance in the account, not on the amount of the overdraft.
This can lead to an avalanche of fees. Veronica Gutierrez, one of the two lead plaintiffs in the case, paid $143 in fees for overdrawing her account by $49. Erin Walker, the other lead plaintiff, paid $506 for a $120 overdraft.
They "sued Wells Fargo under California state law for engaging in unfair business practices by imposing overdraft fees based on the high-to-low posting order and for engaging in fraudulent business practices by misleading clients as to the actual posting order used by the bank."
In August 2010, after a bench trial in San Francisco, U.S. District Judge William Alsup agreed with the plaintiffs, concluding that Wells Fargo "affirmatively reinforced the expectation that transactions were covered in the sequence [the purchases were] made while obfuscating its contrary practice of posting transactions in high-to-low order to maximize the number of overdrafts assessed on customers."
The bank's "sole" motive for processing charges from highest to lowest, Alsup wrote, "was to maximize the number of overdrafts and squeeze as much as possible out of what it called its '[overdraft/returned item] customers.'" This, he argued, was an unfair business practice that violated California's Unfair Competition Law.
The judge ordered the bank to repay its California customers the $203 million it charged in overdraft fees. He also placed an injunction on the high-to-low practice.
Wednesday's Ninth Circuit ruling overturned that restitution order and lifted that injunction, on the basis that national banking laws override the state's consumer laws.
"The ability to choose a method of posting transactions is not only a useful, but also a necessary, component of a posting process that is integrally related to the receipt of deposits," the court stated. "Designation of a posting method falls within the type of overarching federal banking regulatory power that is 'not normally limited by, but rather ordinarily pre-empt[s], contrary state law.'"
The Ninth Circuit did agree, however, that Wells Fargo deceived its customers with "misleading propaganda," and that the district court could order a new payment based on the appeals court's ruling "to determine what relief, if any, is appropriate and consistent with this opinion."