Payday lender Wonga must pay £2.6m in compensation after sending letters from non-existent law firms to customers in arrears.
The letters threatened legal action, but the law firms were false. In some cases Wonga added fees for these letters to customers' accounts.
The City watchdog, the Financial Conduct Authority (FCA), said 45,000 customers would be compensated.
Wonga has apologised and said the tactic ended nearly four years ago.
The company is the UK's largest payday lender, making nearly four million loans to one million customers in 2012, latest figures show.
'Serious'An investigation found that Wonga sent letters to customers from fake law firms called "Chainey, D'Amato & Shannon" and "Barker and Lowe Legal Recoveries".
The plan was to make customers in arrears believe that their outstanding debt had been passed to a law firm, with legal action threatened if the debt was not paid.
The company was using this tactic to maximise collections by piling the pressure on customers, the regulator said.
End Quote Tim Weller Interim chief executive, WongaWe would like to apologise unreservedly to anyone affected"
"Wonga's misconduct was very serious because it had the effect of exacerbating an already difficult situation for customers in arrears," said Clive Adamson, director of supervision at the FCA.
"The FCA expects firms to pay particular attention to fair treatment of those who have difficulty in meeting their loan repayments."
The situation occurred between October 2008 and November 2010, and involved Wonga and other companies within its group.
ApologyAs this happened before the FCA took over the regulation of payday lenders, it is unable to fine Wonga.
Instead, Wonga will start contacting customers in July to offer compensation, with money likely to be paid by the end of the month. This will either be paid in cash or customers will have their outstanding debt reduced.
"We would like to apologise unreservedly to anyone affected by the historical debt collection activity and for any distress caused as a result," said Tim Weller, interim chief executive of Wonga.
"The practice was unacceptable and we voluntarily ceased it nearly four years ago."
Anyone who might have changed address in the intervening period should contact Wonga.
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