A little known loophole is letting some payday loan companies dodge state laws and charge interest rates much higher than the states would otherwise allow, a CNBC investigation has found.
The loophole involves payday lending firms affiliating with Native American tribes and taking advantage of tribal sovereignty to offer loans online that would otherwise be blocked by many US state laws.
Payday lenders—which make short-term cash loans, often to poor or financially struggling customers—target a national audience rather than members of the tribes involved and take advantage of their nominal affiliation with a tribe to charge annual percentage rates of more than 700 percent in some cases.
In some cases, the tribes receive a financial benefit from the payday lending firms — sometimes including a percentage of the overall business. The firms, in turn, lend cash to struggling borrowers at sometimes steep interest rates. (Read More: New Model Breaks From Payday Lender Pack.)
But CNBC found at least one case in which a tribal official said he had no idea a payday lending firm was using the tribe’s name, and, in an interview with CNBC, accused that lender of fraud.
Here’s how it works in one case:
An online lender called Cash Fairy is owned the Fort Belknap Indian Tribe in Montana. On its website, Cash Fairy explains that it is a “Tribal enterprise and economic arm, wholly owned and operated by the Fort Belknap Indian Community ("Tribe"), a federally-recognized sovereign American Indian Tribe, and created by the Tribal Council for the benefit of the Tribe.”
The website advertises cash loans of up to 50 days at an annual percentage rate of 782.14 percent. That means, the website notes, a customer would pay $10.71 to borrow $500 for just one day.
For most companies making loans in New York State, for example, the maximum allowable annual percentage rate is 25 percent.
But Cash Fairy can lend online to people living in New York State because tribal sovereignty means it is not subject to the New York regulations. And it’s operating in a growth area — a 2010 report by JMP Securities found that 35 percent of all payday loans made that year originated online and that share will grow to 62 percent by 2016.
The sovereignty loophole has angered some state leaders across the country, who say non-tribal businesses are simply using a Native American cover to charge exorbitant rates over the internet.
“We started to receive some complaints about outrageous rates, non-disclosure of those rates,” said Colorado Attorney General John Suthers. “And when we went after the payday lenders they showed up and said you can't touch us, we're not subject to your state regulations because we are affiliated with a tribe.” (Read More: 'Shadow Bank' System Will Thrive Under New Rules - Bove.)
But Suthers argues many of the firms aren’t really tribal at all. “These affiliations are very loose,” he said. “In fact, the only affiliation is, ‘allow us to use you as a front and we’ll pay you a small percentage of our gross profit or net profit.’ There’s no physical location on the reservation or anything like. They have unbelievable rates.”
Now the federal government is getting involved. Oregon Senator Jeff Merkley (D) has sponsored the SAFE Lending Act, which would require online lenders to play by the rules established by the state where the borrower resides, not where the business is established. That means a company registered in Oklahoma would have to abide by New York State regulations if it made loans there — a provision that could curtail the flexibility of many of the tribal affiliated lenders.
Merkley told CNBC that payday loans often become rolling debt that can cripple families.
“This has devastating impacts, and its why more than two dozen states have banned these practices — these 400, 500 percent loans,” Merkley said. “And its why we should make sure that when a state has said in democratic fashion that these will not be tolerated in our state, … we do not allow the Internet to be used as a loophole to bypass those state’ s rules.”
But there’s a trade group for tribal lenders, and it doesn’t like Merkley’s legislation — arguing that payday loans are often the only source of credit for poor people who don’t have access to bank accounts or who would otherwise pay bounced check fees.
“The Native American Financial Services Association (NAFSA) mandates that all of its members adhere to all applicable federal lending laws and follow a strict set of Best Practices that ensures consumers and the tribes' sovereignty are equally protected,” said Barry Brandon, the group’s executive director.
“Today, our products serve the 60 million Americans considered under banked who need financial services delivered in a responsible way,” Brandon said. “It is unfortunate that Senator Merkley elected not to consider the recommendations from several Native American associations that were offered as this proposal was being drafted. If he had, his legislation could have made real progress for consumer protection, rather than crippling e-commerce in Indian country and access to the financial products on which so many people rely.”
Payday Lending Even Controversial Within Tribes
The payday lending business can be controversial even within the tribes that are invited to participate in, and profit from, the lending. In one case, a payday lending debate appears to have created a political rift in a tribal council. (Read More: Crackdown Needed in Predatory Lending.)
In January, the tribal council of the Wakpamni District of the Ogala Sioux tribe in South Dakota met to consider a proposal from a consultant who proposed teaming up with a payday lender. The idea bitterly divided the tribal leaders, who debated the finer points of the proposal as well as the morality of payday lending itself.
At one point, a consultant pitching the business to the tribe offered some blunt advice about the very business he was pitching. “My advice is don’t take out a payday loan,” the consultant said, according to a recording of the meeting obtained by CNBC. “Let the white people take out the loan and let us make money off them.”
Ultimately, the decision split tribal leaders, and the meeting came to a head. Tribal President Sandy Two Lance failed to get the support she needed to sign the proposed contract. On the tape of the meeting, however, she says she will sign the deal anyway. “I know you are going to say you can’t do that without the executive board,” she says on the recording. “But I’m going to do it and see where we go. I’m expecting restraining orders after I sign this.”
Another member of the tribal leadership, however, said he was under the impression that the contract was not valid, because the top leaders hadn’t agreed to the deal. And one said he was shocked when CNBC called and pointed out that the payday lending business, FastMoneyStore.net, says on its website that it is affiliated with the Wakpamni District.
“We were not aware of this payday lending project on the Internet until you brought it to our attention,” said Richard Little Hawk, the secretary of the Wakpamni District. “We believe that a fraud has been committed on us and these individuals pulled a fast one on us.”
Here’s where the situation gets even more murky. CNBC contacted tribal president Sandy Two Lance who agreed that her signature on the payday lending contract had not been made according to tribal procedure, but she said she shredded the agreement when other members of the tribe complained. Richard Little Hawk said he has not spoken to Sandy Two Lance in months, and does not know where the tribal president is.
Despite the tribal leadership chaos, the website of FastMoneyStore.net explains that it charges annual percentage rates of more than 782 percent. And it says in fine print that it “is the DBA for the Wakpamni Lake Community of the Oglala Sioux Tribe, a Sovereign Nation. Loans made by Fast Money Store are serviced by Cash Cloud LLC.”
Officials listed in corporate records as affiliated with Cash Cloud LLC did not respond to requests for comment. One of those listed in Arizona state incorporations records as a member or manager of Cash Cloud, Richard Corbridge, said he was not able to comment, and referred CNBC to a man named Chad Jardine, who Corbridge said was the CEO of the firm. However, Jardine left a voice mail for a reporter saying, “I am not the CEO of Cash Cloud.”
He did not respond to a follow up telephone call.
-By CNBC's Eamon Javers