Discover Gets Its Hand Slapped

By Will Ashworth | September 25, 2012 AAA
The Consumer Financial Protection Bureau (CFPB) and the Federal Deposit Insurance Corporation have jointly fined Discover Financial Services (NYSE:DFS) $14 million for using deceptive sales practices, and forced it to refund $200 million to customers who were sold credit card products they didn't need between December 2007 and August 2011. Discover got its hand slapped September 24 and it's not the first company to run afoul of the CFPB in the agency's first year in existence. Shareholders ought to seriously reconsider owning its shares. Despite assurances Discover will clean up its act, history suggests it will happen again.
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How Dare They
Your spouse comes home and tells you he or she's been having an affair for the past few years. Do you forgive and forget? Possibly on the former but not likely on the latter. As a Discover shareholder, how can you turn a blind eye to the company's wanton disregard of 3.5 million customers? Sure this number represents just 7% of the 50 million cards in circulation, but it's hard to trust the word of CEO David Nelms when he says, "As always, we will continue to strive to deliver the highest standards of customer service and satisfaction." This isn't a matter of poor service; it's a deliberate action intended to produce superior results through the use of deceptive sales practices, including failing to disclose material terms and conditions. As is the case with slaps on the wrist, it comes with the usual caveat that Discover has settled without admitting or denying wrongdoing. How convenient.

SEE: Financial Villains: Where Are They Now?

Investor Deception
Do you think if Discover acted in a deceptive manner about its earnings that it would get the same slap on the wrist? Not likely. In October 2009, the American Italian Pasta Company, now part of Ralcorp (NYSE:RAH), was fined $7.5 million and its former CEO and CFO were both sent to prison for 13 to 18 months for fraudulently overstating earnings and deceiving investors. American Italian Pasta had 2004 revenues of $400 million; Discover's 2011 revenues were $7.1 billion. I'm not suggesting in any way there's anything improper about its financial statements. I'm simply pointing out to Discover investors that the likelihood of it deceiving investors in the future rises, given its predilection to deceive customers in the past. The same, in my opinion, can be said for Capital One (NYSE:COF) who was fined $60 million in July and forced to refund $150 million to 2.5 million customers for using the same pressure tactics as Discover. According to the Government Accountability Office, Americans paid $2.4 billion in fees for payment-protection plans in 2009, very little of which resulted in any tangible financial benefit.

SEE: Financial Fraud: Don't Let It Happen To You

The Bottom Line
While Discover and Capital One are not alone in the use of deceptive business practices, they are the first to be fined by the CFPB for doing so. Republicans can whine all they want about the legitimacy of the agency; however, with 5,000 or so publicly traded stocks available, sensible investors should choose to own companies who haven't broken the law. It's common sense really.

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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