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Discover Bank – the banking division of Discover Financial Services (DFS - Analyst Report) – has arrived at an agreement in principle with the Federal Deposit Insurance Corporation (FDIC) and Consumer Financial Protection Bureau (CFPB) to refund $200 million to over 3.5 million cardholders. The settlement is associated with an ongoing litigation against the company.

Since December 2010, Discover has been facing several lawsuits that accuse it of keeping customers uninformed about their buying decisions pertaining to its add-on products. Its telemarketers supposedly enrolled customers into expensive add-on programs without their consent, while the consumers believed that the products were free or they were only agreeing to consider the purchase.

According to the lawsuits, Discover made deceptive telemarketing calls to consumers offering them several optional, fees-based products, including an identity-theft protection plan, a wallet protection plan, a credit-score tracker and a payment protection plan.

However, after informing consumers about the products, the telemarketers used misleading and confusing terms, read scripts quickly, and also omitted disclosures related to the product, leaving consumers confused and misguided. Amid the confusion, customers failed to realize that they were agreeing to buy the product and the telemarketers refrained from informing them that the products were not free.

Last year, Discover revealed in a regulatory filing that FDIC was planning to take enforcement action against Discover Bank in relation to its marketing policies for fee-based products. During 2011, FDIC investigated Discover’s marketing policies for various products including the payment protection plan and the identity-theft protection plan. The findings of the investigation led to the FDIC’s decision of taking action against the company.

However, now Discover has reached a settlement agreement with FDIC and CFPB, whereby it will refund almost $200 million to cardholders who purchased the aforementioned products via telephone between December 2007 and August 2011. These customers will get refunds equal to fees of at least 90 days. Almost 2 million of the 3.5 million recipients will be repaid their entire fee amount.

The agreement also requires Discover to amend its marketing practices and appoint an independent auditor to supervise the fulfillment of the orders. Further, the company will have to pay civil monetary penalties amounting to $14 million, which will be divided between FDIC and CFPB. However, the final approval from both regulatory bodies is yet to be obtained. Meanwhile, Discover will continue to market these products, albeit subject to restrictions.

Discover’s competitors include other financial services companies such as Capital One Financial Corp. (COF - Analyst Report) and SLM Corp. (SLM - Analyst Report). The company currently carries a short-term Zacks #2 Rank (Buy). We maintain a long-term ‘Outperform’ recommendation on the stock.

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