Payday lender Wonga must pay £2.6 million in compensation after chasing struggling customers with fake legal letters in order to pressurise them into paying up.
The firm, which is the UK's biggest payday lender, sent correspondence to about 45,000 customers in arrears from non-existent law firms threatening legal action, the Financial Conduct Authority (FCA) said.
The FCA could not impose a fine on Wonga for what it described as "unfair and misleading" debt collection practices, which happened between October 2008 and November 2010, because the failings were uncovered by a previous regulatory regime and it does not have powers to issue retrospective penalties.
The case, which consumer campaigners described as a "shocking new low" for the payday industry, also saw Wonga add charges to some customers' accounts to cover administration fees for sending the letters.
On top of these historic failings, Wonga has also uncovered another unrelated blunder, which it reported to the FCA in April this year.
This separate technical error resulted in just under 200,000 customers overpaying the company. Wonga is now also contacting these customers to offer compensation, and said the majority overpaid by less than £5.
It said that a greater number of people underpaid as a result of these technical errors, but it will not be seeking repayments from anyone who underpaid.
Wonga has apologised "unreservedly" and said all 45,000 customers who received correspondence from the fake law firms will be pro-actively contacted and offered a flat rate of £50 for distress and inconvenience.
Those who were charged fees for the letters will be refunded. Customers are estimated to have paid £400,000 in charges for being referred to the fictitious law firms. A dditional compensation payments may also be made, depending on individual circumstances.
The process will start by mid-July with compensation likely to be paid from the end of July. The FCA did not pass the matter on to criminal prosecutors to consider for an investigation because it did not want to cause any further delays to people getting their compensation.
Those to whom it owes money will also be paid a standard rate of interest of 8% on the compensation sums as the failings happened some time ago - despite it being suggested during a press conference that Wonga could apply the rate it charges to customers to borrow money. The APR (annual percentage rate) advertised on Wonga's website is 5,853%.
Wonga had contacted customers in arrears under the names Chainey, D'Amato & Shannon and Barker and Lowe Legal Recoveries, leading customers to believe that their debt had been passed to lawyers. Further legal action was threatened if the debt was not repaid.
These firms did not exist and Wonga was using this tactic to pile the pressure on customers to pay up, the FCA said.
Henry Rain, head of regulatory and public affairs at Wonga, confirmed during the press conference that the names of the fake law firms were inspired by people working within the business. But he said that none of these people was responsible for what happened and they knew nothing about the "substance" of what was going on.
Asked if anyone had been disciplined over the fake letters, Mr Rain said that the debt collection practices had stopped before those in the press conference joined the company.
He said that "very few" people from Wonga were involved, adding: "All of the people directly involved in these practices are no longer in the business."
Wonga's poor debt collection practices were originally uncovered by the Office of Fair Trading (OFT) which previously regulated the payday loans market before responsibility was handed over to the FCA earlier this year. The FCA has been clamping down on the whole industry and will shortly consult on capping the cost of a payday loan.
Asked if Wonga felt lucky that it had managed to escape a worse financial penalty, Mr Rain said Wonga's focus is on working with the FCA to help those customers who have been affected.
He said Wonga is fully compliant with all the current regulatory requirements and it does not use outside law firms to collect money.
The OFT referred the whole payday loans industry for a full-scale competition probe after finding "deep-rooted" problems. The Competition and Markets Authority (CMA) plans to publish its full findings from that investigation later this year.
Richard Lloyd, Which? executive director said the case marks a "shocking new low" for the payday industry.
He said: "Wonga deserves to have the book thrown at it."
Martin Lewis, founder of MoneySavingExpert.com said: "This just shows that while Wonga hires expensive marketing, PR and public affairs consultants to try to position itself as 'the good guys in a bad industry', it's all a sham.
"Using lawyers as fake as its puppets, then having the stomach to charge people for it is a thuggish tactic, aimed at scaring and intimidating people who are already struggling."
Mike O'Connor, chief executive of StepChange Debt Charity, said he hoped this would be the first of "many similar actions" as the FCA clamps down on the industry.
Wonga founder Errol Damelin stepped down as its group non-executive board director earlier this month. Mr Damelin co-founded Wonga in 2006 and told the company last November that he wanted to begin a planned exit after stepping down from the role of CEO in order to pursue new business ventures.
Tim Weller, interim Wonga CEO, said today: "We would like to apologise unreservedly to anyone affected by the historical debt collection activity and for any distress caused as a result.
"The practice was unacceptable and we voluntarily ceased it nearly four years ago."
He added: "We will learn from these mistakes and continue working with the FCA to build a better Wonga for the benefit of our customers."
Clive Adamson, director of supervision at the FCA, said: "Wonga's misconduct was very serious because it had the effect of exacerbating an already difficult situation for customers in arrears ."
Wonga customers who think they may have been affected should check the company holds the most up-to-date contact details by visiting wonga.com/apology.