What is a Non-Economic Bank Account Closure?

The four largest banks in South Africa – Absa, First National Bank, Standard Bank and Nedbank – recently announced they would unilaterally close the bank accounts of companies associated with the Gupta family in South Africa.

The four largest banks in South Africa – Absa, First National Bank, Standard Bank and Nedbank – recently announced they would unilaterally close the bank accounts of companies associated with the Gupta family in South Africa.

The banks’ action comes as it is become increasingly clear to the public that the Guptas in South Africa  exercise considerable influence over President Jacob Zuma. The claim is that this extends to members of the family even being able to offer cabinet posts. Their influence is so pronounced it is alleged that state capture has taken place.

The Gupta family has established a network of companies in South Africa ranging from media to mining employing thousands of people. One of the Gupta affiliated companies affected by the closures is Oakbay Resources and Investments , which is traded on the Johannesburg Stock Exchange.

These particular bank account closures are unprecedented in South Africa in two respects: the accounts do not appear to have been closed because of objective economic reasons such as the companies being about to default – the usual reason for such a step. In addition, all four banks took the same step.

For want of better terminology, closing the Gupta bank accounts could be referred to as a “non-economic closure” as opposed to a normal “objective economic closure”. The banks have not given reasons for the closures, citing the confidential nature of customer relationships.

The Banking Association of South Africa issued a statement noting that banks are subject to considerable regulation. In addition, that the four institutions did not collude in cancelling the accounts.

Other firms, including auditors KPMG, have also severed connections with Gupta companies. The reasons cited  by KPMG allude to a reputational risk, which is now being imputed to the banks’ decision to close the accounts.

This article argues that the unilateral closure of accounts for non-economic reasons such as reputational risk undermines civil liberties. This is because exclusion from the banking system effectively excludes citizens, or other legal entities, from the economy, which has serious consequences. These closures should be subject to review by the courts.

Legal precedents in South Africa

South Africa’s Supreme Court of Appeal dealt with a case in which Standard Bank unilaterally closed all the accounts of businessman John Bredenkamp without, initially, providing reasons.

Standard Bank defended its decision based on its contract with Bredenkamp and the common law. Both allowed Standard Bank to unilaterally terminate its contractual relationship with Bredenkamp, or any other client, after giving proper notice without providing any reasons. Bredenkamp, through his legal team, advanced inter alia a novel argument.

They cited a Constitutional Court case (involving an insurance contract) in which the court appeared to rule that contracts had to be fair and reasonable. Bredenkamp’s legal team argued that unilaterally terminating the contractual relationship between the client and bank was neither fair nor reasonable.

The Supreme Court found that the Constitutional Court ruling did not establish a principle that contracts have to be fair and reasonable. It concluded that banks could exercise their contractual rights and close bank accounts as long as this does not involve any public policy considerations or contravene constitutional values.

There are significant differences in the details between Bredenkamp and the Guptas. Bredenkamp, reputed to be a close ally of Zimbabwe’s President Robert Mugabe, was listed as a “specially designated national” by the US Department of Treasury’s Office of Foreign Asset Control. A consequence of this is that US companies can’t trade with South African companies, which have ties to a “specially designated national”. Standard Bank thus had no alternative but to cancel Bredenkamp’s MasterCard account.

The Guptas have not been listed by the US as “specially designated nationals”. Nor are they on any similar list. Obviously – as the Banking Association of South Africa pointed out – the banks have to comply with a host of complex legislation. However, there is no indication which of these the banks used, if any, to close Oakbay’s accounts.

There are also differences between the two scenarios when it comes to the question of commercial implications. In the Bredenkamp case, the court concluded that the commercial implications of closing the accounts were minimal.

The same cannot be said of the Guptas. Oakbay Resources and Investments is a publicly traded company. In addition, Gupta companies have claimed that 7500 of their workers face being laid off if they are not able to operate bank accounts.

Clearly, under these circumstances a bank cannot be seen as merely a private entity entering into a simple contract with another private individual or entity. The closing of the accounts for non-economic reasons raises considerable public policy issues. This makes the matter one that should be under the purview of the courts.

Access to the payment system

Does the closing of bank accounts also infringe upon “constitutional values”? Constitutional issues should in the first instance be approached from general principles. The most fundamental are found in the preamble to the American Declaration of Independence, which articulates universally accepted principles, the rights to life and liberty. These were earlier expounded by the English philosopher John Locke, who pointed out that the right to liberty included the right to work.

It can be argued that courts have a duty to protect liberty and with it the right to work. Banks are unique in this regard because they provide access to the payment system of the economy. Without this access, the right to work is subverted. Any business cut off from the payment system will effectively have the life choked out of it. Thus, it can be argued that excluding someone from the payment system also has significant constitutional considerations. This again brings the matter under the purview of the courts.

The US’s operation choke point

Recent developments in the US brought to light attempts by government agencies to use the banking system to arbitrarily close down businesses they deem to be undesirable. Two investigations – one by the Wall Street Journal in 2013 and the other by the Washington Post in 2014 – found that the US Department of Justice and various regulators had launched a secretive initiative to put pressure on banks to close, for non-economic reasons, the accounts of a range of businesses.

The businesses included legitimate arms and ammunition dealers, short-term lenders, escort services, lottery sales, pawnshops, telemarketing, dating services, coin dealers and numerous others. The justice department called this secret initiative “Operation Choke Point”.

Banks found to be dealing with these industries faced what was termed “reputational risk”. They also carried the risk of subsequent investigations by the agencies with the possibility of being fined. Closing the accounts avoided potential investigations and mitigated these risks. Banks decided that the easiest course of action would be to close the accounts, which they started to do.

A number of investigations were launched.  In May 2014 the Chairman of the House Financial Services Committee wrote to Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, and others expressing concern over the growing use by regulatory agencies of “reputational risk” as a vehicle for attacking legitimate businesses instead of assessing accounts using the normal objective measures.

Operation Choke Point was also investigated by a Congressional Oversight committee, which concluded that the administration had not operated within the bounds of the law. It was discouraging and inhibiting lawful conduct of honest merchants. It was therefore necessary to dismantle Operation Choke Point and return to objective risk assessments in deciding whether to close bank accounts.

The point that needs to be made clear is that banks, as part of the payment system, are not normal private institutions. Closing down bank accounts for other than the normal objective economic reasons raises both public policy and constitutional concerns. These closures should therefore, at least, be subject to judicial oversight.

Why there needs to be Judicial Oversight of Bank Account Closures is republished with permission from The Conversation