Discover Financial Services (DFS) stock fell as much 15% in trading on Thursday after it disclosed regulatory issues involving the misclassification of its credit cards in its second quarter earnings report.

Why Does This Matter?

Since mid-2007, the company incorrectly classified some credit cards into its highest pricing tier. While the cardholders were not affected, merchants were charged more than they should have been to accept the cards.

Though the revenue impact is not material for the financial statements, the company has calculated a $364 million liability to provide refunds to merchants. The actual amount of refunds may d🅘iffer, gi𝓡ven differences in merchant agreements and the availability of historical data.

While an internal review of compliance, risk management,ꦚ and corporate governance is pending, Discover paused its share buybacks. During the second quarter, the Illinois-based digital banking provider repurchased about 6.8 million shares for $700 million.

A♔n external law firm will investigate this matter while Discover is in discussions with regulators.

༺Additionally, Discover is facing an additional consumer compliance probe from the FDIC, which does not include the card misclassification matter. The lender warns that it may face additional supervisory actions going forward.

Regulatory challenges aside, Discover's net income dropped by 18% year-on-year in the second quarter to $901 million. This was partly owing to a higher provision for credit losses which increased by $756 million to $1.3 billion. Operating expenses increased by $173 million year-on-year, driven primarily by investments in compliance management systems.

Total revenue net of interest expense increased by 21% to $3.88 billion through a 4% increase in deposit base, higher net interest income, and higher loan fee income.

Until yesterday, Discover shares had gained more than the S&P 500 since the start of the ye🀅ar. However, that trend reversed Thursday as Discover shares fell off a cliff.