The battle over surcharges has raged for decades. The card brands, merchants and even regulatory bodies have fought hard to prevail. What’s the latest? Read on to find out.

Credit card brands hate allowing merchants to charge consumers more when they use a credit card. Decades ago, the payment brands began placing contractual restrictions, through their rules, on retailers that prevented them from charging credit card users higher prices than cash customers. Congress put a partial stop to this practice through the Truth in Lending Act of 1974 and subsequent amendments, which outlawed contractual provisions in credit card merchant agreements preventing the use of cash discounts. As a result, card companies could not prohibit cash discounts, but they could forbid credit card surcharges in their merchant agreements. And they did.

Congress put a partial stop to this practice through the Truth in Lending Act of 1974 and subsequent amendments, which outlawed contractual provisions in credit card merchant agreements preventing the use of cash discounts.

Visa and MasterCard responded with new rules that allowed cash discounts but banned surcharges. Although the definition of what constitutes a cash discount versus a surcharge would be fought about for the next two decades, Visa currently takes the position that a “cash discount” occurs when a merchant posts credit card prices and offers a discount on that price for customers who pay with cash. For instance, when a merchant posts the full price along side a discounted price for paying for the product in cash, the merchant is selling utilizing a cash discount. On the other hand, when a merchant adds a fee to the transaction, that constitutes a surcharge. And to complicate matters further, the brands permit “convenience fees” in limited circumstances for fixed amounts for all tickets.

Visa currently takes the position that a “cash discount” occurs when a merchant posts credit card prices and offers a discount on that price for customers who pay with cash.

In the next step in this saga, merchants sued the brands alleging a variety of antitrust claims, including that the brands conspired to prohibit merchants from charging different prices for cash and credit, and adding the credit card fees to the transactions. As part of a 2013 settlement to the lawsuit, both Visa and MasterCard agreed to allow surcharging, but set up barriers to strongly discourage the practice. For instance, Visa requires each merchant to:

1. Notify Visa at least 30 days in advance of beginning to surcharge;
2. Limit surcharging to credit cards only (no surcharging debit and prepaid cards);
3. Cap the amount of the surcharge to the merchant’s discount rate for the applicable credit card surcharged, and to no more than 4 percent;
4. Disclose the surcharge as a merchant fee, and clearly alert consumers to the practice at the point of sale – both in store and online – and on every receipt; and
5. (Most surprising given the nature of the antitrust lawsuit that gave rise to the authorizing surcharging rule) Visa says a merchant can choose to surcharge Visa and not other card brands, but merchants must surcharge Visa on the same terms and conditions as competitors.[1]

It is a rare merchant that finds complying with these rules worth the effort. In many instances, the merchants decide they are better off just continuing to eat the transaction cost.

As part of a 2013 settlement to the lawsuit, both Visa and MasterCard agreed to allow surcharging, but set up barriers to strongly discourage the practice.

While the card brands and the merchants fought about surcharging, several states, including California, Florida, Massachusetts, New York, and Texas, enacted laws that make credit card surcharges illegal.[2] Merchants, in turn, began a series of lawsuits challenging these statures as unconstitutional based upon free speech grounds. In New York, the challenge to the surcharge ban went all the way to the Supreme Court of the United States (“SCOTUS”).

The case, Expressions Hair Design v. Schneiderman, centered on merchants’ arguments that the prohibition on credit card surcharges under New York General Business Law Section 518 (“Section 518”) constituted an unlawful restriction of speech in violation of the First Amendment. A group of merchants wanted to use a pricing model with single stickers, i.e. one price for each product, compared to stickers that identified a credit card price and a cash discount price. The merchants wanted to put up signs that would indicate a surcharge of either a flat dollar amount or a percentage of the total cost added for the use of credit cards.

On appeal, SCOTUS held that Section 518 does regulate speech as applied to these specific retailers, and remanded the case to the Court of Appeals to determine whether the regulation survived scrutiny as a speech regulation and whether the statute was vague as to the merchants.

These merchants filed a lawsuit against state officials, arguing that Section 518 restricted how they communicate their prices and effectively prohibited them from advertising the extra costs imposed on them to accept credit cards. The District Court ruled in favor of the merchants. Then, the Second Circuit Court of Appeals reversed, holding that the law required the sticker price of cash and credit card payments to be the same and, therefore, regulated conduct rather than speech.[3] On appeal, SCOTUS held that Section 518 does regulate speech as applied to these specific retailers, and remanded the case to the Court of Appeals to determine whether the regulation survived scrutiny as a speech regulation and whether the statute was vague as to the merchants.[4]

With the First Amendment now in play, the Second Circuit was then tasked with analyzing whether Section 518 is a valid commercial speech regulation, and whether the law could be upheld as a valid disclosure requirement.[5] The Second Circuit, in turn, kicked the question to the New York Court of Appeals to determine “whether a merchant complies with Section 518 so long as the merchant posts the total dollar-and-cents price charged to credit card users.”[6]

In a closely divided decision, the New York Court of Appeals held that the surcharge practice is acceptable so long as no arithmetic is involved, and customers need not calculate what the differential is themselves.[7] But merchants may not, as they sought to do, simply list the cash price and then list a surcharge of X percent or X dollars. (Yes, lawyers and judges hate math.)

Almost immediately, the New York Attorney General settled the lawsuit on terms that allowed these merchants to surcharge when the merchants post total prices for credit card purchases in dollars and cents. The settlement was likely a way for the New York Attorney General to save face and to attempt to keep some portion of its surcharging law.

In a closely divided decision, the New York Court of Appeals held that the surcharge practice is acceptable so long as no arithmetic is involved, and customers need not calculate what the differential is themselves. (Yes, lawyers and judges hate math.)

Surcharging bans on the state level are on their way out. In light of SCOTUS’s First Amendment ruling, merchants are challenging other state laws.

In Rowell v. Paxton, a federal district court declared Texas’s surcharge law unenforceable, reversing a previous decision from 2016 that the law was an ordinary business regulation.[8] The court found that under Expressions, the law must be evaluated as a regulation on speech, and the state failed to meet the high legal standard required to restrict the speech of these merchants.

Meanwhile, the Ninth Circuit recently evaluated California’s law and held that “the statute as applied to these plaintiffs violates the First Amendment.”[9] Florida’s law was found to be an unconstitutional abridgment of free speech even before Expressions came down.[10] And as long as the surcharge is clear and conspicuous to the consumer, even to the level of doing the math for the consumer, states will be hard pressed to say these laws are legitimate limits on speech.

The unlikely enemy of surcharge ban laws: free speech.

The key takeaway of the current landscape of surcharging is that laws banning surcharging are on the way out due to free speech concerns. Nevertheless, merchants will have to continue to comply with the card brands’ Draconian rules regarding surcharging that make it unlikely that surcharging will appeal to more than a small segment of merchants.

References

1] Source: https://usa.visa.com/dam/VCOM/download/merchants/surcharging-faq-by-merchants.pdf

[2] States that have enacted surcharge bans include: California (Cal. Civil Code §1748.1); Colorado (Colo. Rev. Stat. §5-2-212); Connecticut (Conn. Gen. Stat. §42-133ff); Florida (Fla. Stat. §501.0117); Kansas (Kan. Stat. Ann. §16a-2-403); Maine (Me. Rev. Stat. Ann. tit. 9-A, §8-509); Massachusetts (Mass. Gen. Laws Ann. ch. 140D, §28A); New York (N.Y. General Business Law §518); Oklahoma (Okla. Stat. tit. 14A, §2-211); and Texas (Tex. Business & Commerce Code Ann. §604A.001 et seq. and Tex. Finance Code Ann. §339.001). Puerto Rico (P.R. Code Ann. tit. 10, §11) also has a surcharge ban. Meanwhile, Minnesota limits the amount of surcharges to 5% and requires both an oral statement and a conspicuously posted sign informing purchases of the surcharge (Minn. Stat. §325G.051) while Georgia explicitly permits convenience fees (Ga. Code §13-1-15).

[3] See Expressions Hair Design v. Schneiderman, 137 S. Ct. 1144, 1145 (2017).

[4] Id. at 1147.

[5] Expressions Hair Design v. Schneiderman, 877 F. 3d 99, 102 (2nd Cir. 2017).

[6] Id. at 103.

[7] Expressions Hair Design v. Schneiderman, NY Slip Op 07037 (Oct. 23, 2018).

[8] Rowell v. Paxton, Case No. 1:14-CV-00190 (W.D. Texas Aug. 16, 2018).

[9] Italian Colors Restaurant v. Becerra, 878 F. 3d 1165, 1167 (9th Cir. 2018).

[10] Dana’s RR Supply v. Attorney General, 807 F. 3d 1235, 1239 (11th Cir. 2015).

The post Surveying Surcharges: Credit Card Surcharge Laws & Recent Legal Trends appeared first on Genco Payments.

In the first two parts of this three-part blog series, we reviewed a number of issues and concerns that can stem from businesses accepting cryptocurrencies like Bitcoin, Litecoin and Ethereum for payment. The U.S Treasury Department’s Financial Crimes Enforcement Network (FinCEN) and  the Internal Revenue Service (IRS) are just some of the federal bodies that have issued guidances and rulings pertaining to this kind of digital currency.

In this third and final installment in this blog series, we will review guidances on cryptocurrencies issued by other federal government agencies, as well as how some state-level government and industry oversight bodies have discussed these digital currencies.

Cryptocurrencies and refunds

Issuing refunds on transactions conducted via a digital currency could present logistical challenges for some businesses. For starters, will an organization be able to afford to issue a refund down the road if the price of their chosen accepted cryptocurrency drops between when payment is rendered and when a refund is requested?

The Federal Trade Commission (FTC) requires companies to offer their customers refunds in certain situations. Organizations which must comply with this FTC rule need to be clear with customers whether refunds will be issued via cryptocurrency or in government-issued tender.

This FTC rule regarding refunds also applies to Bitcoin Merchant Service Providers (BMSPs), which are the organizations that facilitate transfers between different cryptocurrencies and between these digital currencies and government-issued tender. However, an advisory issued by the Consumer Financial Protection Bureau (CFPB) noted “that though it is illegal for a virtual currency exchange to operate without registering with FinCEN, the registration does not, on its own, mean that an exchange is trustworthy.”

Professional oversight bodies and potential ethical considerations

For some organizations, especially those like law firms that must follow strict ethical guidelines, the volatility inherent in most cryptocurrencies at the moment can present problems.

For instance, the Nebraska Rule of Professional Conduct prohibits attorneys from making clients pay “unreasonable fees” for services rendered. Due to the ever-changing nature of Bitcoin’s price, for example, a firm that charged one bitcoin for a particular service in 2018 would be asking for something very different in return if that same organization asked for one bitcoin in 2008 as well. As such, a special ethics council appointed by the Nebraska Supreme Court ruled in 2017 that attorneys can accept cryptocurrencies for payment only if these payments are immediately transferred into accepted government tender.

State-level considerations

Different state-level bodies have issued different guidances and guidelines relating to Bitcoin and other similar digital currencies. It behooves organizations to understand how states where they operate in any fashion have ruled on and/or discussed cryptocurrencies.

For example, New York state requires businesses that buy, sell or trade cryptocurrencies, or engage in similar kinds of activities, to register with the state’s Department of Financial Services. However, merchants that only use these kinds of digital currencies to sell or buy services and/or goods are currently exempt from this requirement.

Connecticut has taken a similar tack as New York. In 2015, state officials amended the Connecticut Money Transmission Act to specifically account for cryptocurrencies. Now, organizations that operate in the state must have a license as a Virtual Currency Business if “any type of digital unit that is used as a medium of exchange or a form of digitally stored value or that is incorporated into payment system technology.”

In California, the ability to buy or sell goods or services with anything other than government-issued tender has only been deemed legal according to state law since 2014. The California Department of Business Oversight may require cryptocurrency users to register with the state, but no definitive action has been taken in this regard as of yet.

Other states, however, have taken much different stances regarding these sorts of virtual currencies. For instance, the State of Texas noted in 2014 that cryptocurrencies are not considered as money and do not have monetary value as that term was previously defined in its Money Services Act.

Potential future considerations

Even bitcoin, perhaps the currently best known cryptocurrency, is still relatively new. As such, many state and federal government agencies may issue future declarations and guidelines pertaining to these kinds of digital currencies.

In particular, a number of observers have noted that cryptocurrencies could be perceived as violating the Stamp Payments Act of 1862. However, these virtual currencies are not physical tender and are not (yet) perceived as being a “legitimate contender to the U.S. dollar,” so are unlikely to be viewed as being in violation of this law in the near future.

Many businesses either already accept cryptocurrencies like Bitcoin for goods and/or services, or are considering doing so. However, before a company makes a decision regarding these virtual currencies, they could be aware of current rules and regulations pertaining to cryptocurrencies. A law firm that specializes in payments processing-related issues and concerns can help a business to navigate the ever-changing cryptocurrency legal landscape.

Read Part 1 and Part 2 in the series.

The post Accepting Bitcoin for Payments: The Legal Basics Part 3 of 3 appeared first on Genco Payments.

Cryptocurrencies like Ethereum and Bitcoin have become more well-known over the past few years. As they gain in notice, many businesses have started to consider accepting these kinds of digital currencies for payment. However, before organizations elect to do so, they may find it beneficial to understand the legal issues and other nuances of accepting cryptocurrencies instead of just government tender.

In the first part of this three-part blog series, we reviewed the basics of how most of these cryptocurrencies work and how the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has begun viewing these digital-only currencies in light of current standing laws related to money laundering and rules stemming from the Bank Secrecy Act (BSA).

In the second part of this blog series, we review how different government agencies, including other federal departments, view cryptocurrencies like Bitcoin. We will also review other considerations organizations may want to consider before deciding to accept cryptocurrencies as payment for goods and/or services rendered.

Tax considerations with cryptocurrencies

Cryptocurrencies do not fall outside the purview of tax collection in the United States. The Internal Revenue Service (IRS) has classified cryptocurrencies like Bitcoin as property. In March 2014, the IRS issued guidance that specified cryptocurrencies as property and not as foreign currency.

As a result of its classification, businesses also need to report any capital gains or losses sustained from buying or selling these kinds of digital currencies. In an article published by the American Bar Association, Stephen T. Middlebrook, co-chair of the Electronic Payments Subcommittee of the ABA Business Law Section’s Cyberspace Law Committee, spelled out some of the way the IRS classification of cryptocurrencies can affect a company’s taxes:

“[I]f a person accepts a bitcoin on Monday when the value is $400 and then makes a purchase with that same bitcoin on Friday when the value is $410, he or she has a $10 gain. Imagine a merchant that acquires bitcoin in multiple transactions over a month during which the price of bitcoin fluctuates. Its basis in each individual bitcoin may be different depending on the market price at the time of the transaction. When the merchant decides to cash out some of its bitcoin for dollars, it will need to decide not just how much bitcoin to sell but also which particular bitcoins to part with – because exchanging this bitcoin over that bitcoin will determine the amount of a reportable gain or loss.”

Cryptocurrency exchange services

Likely, any business that accepts Bitcoin or any other type of cryptocurrency for payments will want to exchange that digital currency for government-issued tender like U.S. dollars at some point. However, there are a number of considerations that organizations will have to work through in considering how to go about this.

As FinCEN’s 2017 ruling against money transmitter BTC-e highlights, companies risk running afoul of provisions from the BSA related to money laundering. To avoid working with the wrong Bitcoin Merchant Service Provider (BMSP), companies may want to clarify a BSMP’s guidelines around refunds, risk settlement, exchange rates, disclosures, fees and privacy.

Some BSMPs are registered as Money Service Businesses (MSBs), which means they are supposed to comply with rules and regulations spelled out in the BSA. A number of BSMPs are also registered with various state-level bodies created to oversee those who are buying and selling cryptocurrencies. However, the Consumer Financial Protection Bureau (CFPB) has noted that even BSMPs which are registered as MSBs may not be “trustworthy.”

Unlike banks, the vast majority BSMPs are not insured by the Federal Deposit Insurance Corporation (FDIC). If theft or amalfeasure occurs with a BMSP, its users would have very limited to no assistance from the FDIC in the matter. This is one of the many reasons why the CFPB has said that there are “a lot of big issues” with Bitcoin and other similar digital currencies.

Volatility and exchange rates

The value of cryptocurrencies is determined entirely by market demand. As such, the price of one unit can change dramatically in a relatively short amount of time. For example, during one 10-minute stretch on November 29, 2017, the price of one bitcoin decreased by $1,000.

This occasional volatility can mean that merchants may encounter difficulties navigating conversion rates. For example, if a hot dog vendor accepts one litecoin on a Monday, they could end up losing money should the exchange rate drop in the hours and day following the initial transaction.

However, in comparison to transactions and exchanges handled by banks or other similar financial institutions, BSMPs typically do not charge any fees when facilitating a transaction.

In the third and final part of this blog series, we will review additional legal considerations that organizations may want to consider, especially at the state level. We will also review some of the elements of cryptocurrencies that some businesses see as making it beneficial and help to positively differentiate it over traditional currency.

Contact us today to discuss your payments legal needs info@tfmlaw.com

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The Court will rule on the Hemp Industries Association’s (“HIA”) claim that the Drug Enforcement Agency (“DEA”) overstepped its authority when it issued a new rule creating a controlled substances code number for marihuana extract.

On February 15, the Ninth Circuit Court of Appeals will issue a decision that will have far-reaching consequences in the industrial hemp industry.

What is marihuana extract?

The challenged rule defines marihuana extract to include “an extract containing one or more cannabinoids that has been derived from any plant of the genus cannabis, other that the separated resin (whether crude or purified) obtained from the plant.”

HIA v. DEA — Is Industrial Hemp a Controlled Substance?

While DEA contends it uses such drug codes merely for tracking purposes, HIA alleges that DEA and other agencies have applied the marijuana extract code to treat industrial hemp as a controlled substance — in violation of both federal law and congressional intent.

HIA alleges that DEA’s actions in issuing the rule constitute an unlawful scheduling action in violation of the Controlled Substances Act (“CSA”).

Moreover, DEA has made its position clear: CBD oil and other extracts derived from cannabis (including hemp) are Schedule I controlled substances.

HIA alleges that DEA’s actions in issuing the rule constitute an unlawful scheduling action in violation of the Controlled Substances Act (“CSA”). Why? According to HIA, DEA fails to distinguish between industrial hemp/hemp-derived materials and psychotropic marijuana — despite Congress requiring DEA to make these distinctions pursuant to the CSA and the 2014 Farm Bill.

HIA’s Two Key Arguments: Lack of Definition and a Carve-Out

HIA advances two primary arguments in support of its position:

First, the CSA does not define cannabis. Instead, it defines only marihuana as a controlled substance, and it exempts several parts of the cannabis plant from that definition.

CSA does not define cannabis.

Second, non-exempted parts of the cannabis plant have been carved out from the CSA and/or deemed lawful under other federal statutory provisions — including the 2014 Farm Bill and the Consolidated Appropriations Act of 2016 (“Spending Act”).

History Repeating Itself? 2004 HIA v. DEA Battle Appeared to Set Precedent

It bears emphasis that, in a previous lawsuit filed by HIA against DEA more than a decade ago, the Ninth Circuit held that at least one naturally occurring cannabinoid (THC) was lawful so long as it is not derived from marihuana or unlawful/unapproved parts of the plant.

A 2004 court decision involving DEA and HIA may shed some light on the outcome of this current dispute.

In that case, the Court permanently enjoined DEA from enforcing rules:

(i) adding hemp stalk, seed and oil containing non-psychoactive minuscule trace amounts of residual resin containing naturally occurring THC to Schedule I of the CSA, and

(ii) narrowly exempting only those hemp products not intended for human consumption.

The Court’s reasoning in that case appears closely analogous to the situation presented here.

The CSA defines marihuana to exclude “the mature stalks of such plant, any other compound, manufacture, salt, derivative, mixture or preparation of such mature stalks (except the resin extracted therefrom), fiber, oil or cake, or the sterilized seed of such plant…” 21 U.S.C. 802(16).

DEA and HIA disagree over a definition.

Thus, in reaching its 2004 decision, the Ninth Circuit held that: “Congress was aware of the presence of trace amounts of psychoactive agents (later identified as THC) in the resin of non-psychoactive hemp when it passed the 1937 Marihuana Tax Act, and when it adopted the Tax Act marijuana definition in the CSA. … Congress knew what it was doing and its intent to exclude non-psychoactive hemp from regulation is entirely clear.”

The Court concluded that DEA’s rules were inconsistent with the unambiguous meaning of the CSA definitions of marijuana and THC.

What’s Changed Since Then: Farm & Spending Bills Allow Greater Latitude

Since that time, Congress has passed the 2014 Farm Bill, which defines and clearly permits the growth, cultivation and research of industrial hemp under defined parameters. The Farm Bill’s definition of industrial hemp includes any part of the plant, including the flower. Rather than having the distinction between industrial hemp and marihuana depend on the part of the cannabis plant from which a product is derived (as it is under the CSA), the Farm Bill distinguished the two based on the concentration of THC in each product.

The 2016 Spending Bill expressly prohibits the government from spending funds in contravention of 2014’s Farm Bill.

In 2016, Congress passed the Spending Bill. It expressly prohibits the government from spending funds in contravention of the Farm Bill, and further prohibits DEA from interfering with the interstate transportation of industrial hemp grown pursuant to the Farm Bill.

DEA Stands Its Ground

DEA contends that marihuana extract is a “subclass of the materials” the CSA already defines as marijuana. DEA asserts that HIA waived any right to challenge the marihuana extract rule, because petitioners failed to participate in DEA’s rule-making proceedings.

DEA asserts that the rule is well within its authority to promulgate regulations necessary and appropriate to control CSA-listed substances.

DEA also asserts that HIA lacks standing to challenge the rule on the grounds that it inflicts no injury on HIA. According to DEA, the rule simply adjusts DEA’s administrative methods for tracking substances the federal government has long controlled.

Finally, DEA asserts that the rule is well within its authority to promulgate regulations necessary and appropriate to control CSA-listed substances.

Congress Weighs in to Support HIA

However, Congress has filed its own amicus brief supporting HIA’s position. Congress argues that — in passing the Farm Bill and Spending Bill — it sought to clearly establish rules that both the Executive Branch and individual states must follow in order to research the viability of industrial hemp as an agricultural crop.

Congress deliberately recognized that industrial hemp products derived from any part of the plant can be used for many industrial purposes.

By passing the Farm Bill, Congress deliberately recognized that industrial hemp products derived from any part of the plant can be used for many industrial purposes, and they would not fall under the CSA’s definition of marihuana so long as the plant was cultivated to be below 0.3% THC concentration.

Congress argues that DEA did not properly interpret the text of the statute; that was what led Congress to pass the above-described Spending Bill provisions in the first place.

Thus, Congress asks the Court to recognize and honor the actions and purpose of Congress, and to find that the marihuana extract rule constitutes an abuse of DEA’s administrative procedure and rule-making authority.

Upcoming Decision Leaves a Question Mark for National Enforcement

The Ninth Circuit includes 15 federal judicial districts located in Alaska, Arizona, California, Guam, Hawaii, Idaho, Montana, Nevada, North Mariana Islands, Oregon and Washington. Thus, the Ninth Circuit’s decision will not resolve the question on a national level.

The Ninth Circuit’s decision could have far-ranging implications for payment processing and banking in the CBD industry.

However, a positive ruling for the HIA will likely ease the way for more banks and payment processors to process payments and otherwise bank CBD businesses.

Theodore F. Monroe is an attorney whose practice focuses on the electronic payment and direct marketing industries. For more information, email him at monroe@tfmlaw.com or call him at 213-233-2273.

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Whether or not other states follow the Keystone State’s lead, this decision will have devastating consequences for emerging payment companies, especially those who do not have the resources of traditional old line processors. Many may well be faced with the prospect of either banning Pennsylvania consumers or leaving the nonprofit and religious processing space.

On September 29, 2015, the Pennsylvania Department of Banking and Securities issued an advisory that its money transmitter regulations are violated when payment facilitators or ISOs collect money from consumers and forward it to nonprofits and religious organizations. In fact, the advisory, according to its plain language, would ban all traditional payment processing for nonprofits and religious organizations by any company that is not licensed as a money transmitter. (The state also issued a news release defending its decision.)

Although the Department directed the advisory to Pennsylvania’s nonprofit and religious organizations to warn about the risks of using unlicensed electronic payment service providers to collect charitable donations, it is the payment facilitators and ISOs operating within the state that are going to feel its impact. For instance, the advisory does not distinguish between a payment entity that settles the money into its own account and one that transmits funds directly from the acquiring bank to a non-profit/religious institution.

This another example of the continuing technological innovation in the payments sphere leading to uncertainty in the law and conflicting regulatory approaches between federal and state regulators as to the legal status of various money services businesses.

One key issue that is very much in flux is what types of business activities qualify as “money transmission” activities requiring federal registration and/or state licensing as a money transmitter. Depending on how and where a payment facilitator is doing business, it may be subject to federal registration requirements with the Financial Crimes Enforcement Network (“FinCEN”) pursuant to the Bank Secrecy Act (“BSA”), without being subject to state licensure requirements. Or it may be subject to licensure requirements in some states, but not in other states or under federal law.

This presents particular challenges to young emerging payments companies, which often lack experienced legal teams to track the frequent changes in the law. Those businesses may also lack the resources to undertake the costly and time-consuming process of getting licensed as a money transmitter in every state where they operate.

The advisory admonishes that any person selling services to “non-profits, religious organizations, charities and political campaigns (“third-party recipient”) for the movement of money from a donor’s bank account or credit card to the account of a third-party recipient” must be licensed as a money transmitter under Pennsylvania law, regardless of whether the transmission is executed by the service provider through its own banking institution, or forwarded to a payment processor for processing through the ACH system. All persons subject to licensure as a money transmitter in Pennsylvania are also subject to the additional statutory requirements that they carry a $1 million liability bond and have a minimum net worth of at least $500,000. (7 P.S. §6102).

Significantly, the advisory said that payment processors and ISOs must be licensed to perform such money transmission activities. This is in direct contrast to federal law, which expressly excludes payment processors and ISOs from the federal registration requirements for “money transmitter” money services businesses under the BSA, provided they qualify for the “payment processor exemption” by satisfying four mandatory conditions:

• The entity must facilitate the purchase of goods or services, or the payment of bills for goods or services (other than money transmission itself)
• The entity must operate through clearance and settlement systems that admit only BSA-regulated financial institutions (such as the ACH) or are themselves regulated institutions (such as operators of credit cards)
• The entity must provide the service pursuant to a formal agreement
• The entity’s agreement must be at a minimum with the seller or creditor that provided the goods or services and receives the funds. (See FIN-2014-R009, “Application of Money Services Business Regulations to a Company Acting as an Independent Sales Organization and Payment Processor”, August 27, 2014.)

The Department emphasized that “the fact that the federal government may have determined that the activity engaged in by [companies fitting within the payment processor exemption] is not money transmission for purposes of federal law is irrelevant to a determination that one is acting as a money transmitter for purposes of state law and the need to comply with state law” because of the distinctly different purposes behind the federal and state statutes in question. The advisory said that the “purpose of the designation of a money transmission under federal law is to further compliance with the Bank Secrecy Act and to prevent the use of the banking system in furtherance of an illegal or criminal activity.”

In contrast, Pennsylvania’s state licensing requirements for companies selling money transmission services to non-profits and charitable organizations aims to provide protection for the donor’s funds through the net worth and bond requirements of the statute. Under the language of the advisory, any religious organization using any payment processing service would be banned unless the service is licensed in the state.

Of course, electronic payment service companies affected by the advisory may avoid the impact of the Department’s decision by simply not doing any business with Pennsylvania consumers. Yet that is a questionable strategy, especially given the likelihood that at least some states will follow Pennsylvania’s example.

Another option is to implement contractual changes and/or vary the structure of their business activities such as offering a good or service to the consumers, to qualify for other exemptions from such licensing requirements. Potential solutions must be evaluated on a case-by-case basis, however, and may satisfy some regulatory licensure schemes but not others. One thing for certain is that the problem is not going away anytime soon.

The post State Money Transmitter Rule Slams PFs, ISOs appeared first on Genco Payments.

Before 2002, the FTC had never sued an ISO. Since then, however, it has filed at least seven lawsuits against payment processors for facilitating merchant fraud. This trend seems to be gaining momentum.
To establish liability, the FTC relied on Section 5 of the 1914 FTC Act and the Telemarketing Sales Rule (TSR), which was enacted in 1995.

Section 5 is the basic federal consumer protection statute that allows the FTC to take action against unfair or deceptive business practices. The TSR protects consumers against businesses that engage in or facilitate fraudulent telemarketing.

The FTC takes aim

In February 2002, the FTC initiated its first lawsuit against an ISO when it sued Certified Merchant Services Ltd. under Section 5. The lawsuit alleged CMS and its third-party sales agents unfairly and deceptively modified customer contracts, debited customer accounts without authorization, failed to disclose charges and fees, and misrepresented various goods and services offered.

CMS agreed to pay $23.5 million to settle the charges. Payment to the FTC came from a forced sale of CMS’ assets.

In July 2003, the FTC filed suit against Electronics Financial Group and its principals. EFG provided a variety of electronic payment services to clients in the United States and Canada, including electronic debits and credits to consumer bank accounts through the automated clearing house (ACH) networks.

The EFG case is striking. Unlike the CMS case, which involved unfair business practices against consumers perpetrated directly by the ISO, EFG’s liability was premised on the unlawful conduct of its merchants. In particular, the FTC alleged EFG violated the law by doing the following:

• Providing assistance to merchants engaged in the deceptive marketing of advance-fee debit cards
• Processing ACH transactions on behalf of merchants engaged in outbound telemarketing to consumers with whom the merchants had no relationship. This activity was unfair in the eyes of the FTC because NACHA – The Electronic Payments Association operating rules (by which all processors are bound) specifically prohibit processing this type of transaction.
• Providing substantial assistance and support to numerous telemarketing clients who EFG knew or should have known were engaged in business practices that violated the TSR.

EFG ultimately paid $3.9 million to settle the suit. The settlement banned EFG from processing any telephone-initiated sales through the ACH network.

The offensive expands

The FTC filed a similar action against First American Payment Processing Inc. in January 2004. Once again, it relied on Section 5 and the TSR. The FTC sought to hold First American liable for processing ACH transactions on behalf of merchants engaged in fraudulent outbound telemarketing, not for any deceptive act vis-à-vis consumers by First American.

First American paid $1,580,739 to settle this case. It also agreed to halt processing payments for outbound telemarketers.

In August 2005, Universal Processing Inc. and its principals were subject to yet another FTC action. It was premised on the unlawful conduct of Universal’s merchants, not on the processor’s actions. The FTC alleged that high return rates should have tipped Universal off that it was processing unauthorized charges even though, in reality, Universal had no way of knowing consumers had not authorized debits.
Universal ultimately entered into an agreement with the FTC to settle the matter. That agreement specified that the settlement did not in any way constitute an admission of guilt on the part of Universal.

More processors hit

The FTC filed two more actions against ISOs in December 2006. The first alleged the payment processing businesses owned and/or controlled by Ira Rubin violated the TSR by aiding at least nine malicious, Canada-based, advance-fee credit card schemes. The subterfuge induced consumers to allow electronic debits from their bank accounts in exchange for unsecured credit cards. Many consumers never even received the cards.

The FTC alleged Rubin and his companies provided processing services despite receiving complaints from consumers, law enforcement and Better Business Bureau chapters concerning the deceptive and abusive business practices of its merchants.

The second action was against InterBill Ltd., a payment processor servicing high-risk merchants, such as online gambling Web sites and MO/TO marketing companies. The FTC alleged InterBill violated the FTC Act by debiting consumer bank accounts despite clear red flags that its merchants were submitting illegal transactions for processing.

It is worth noting the FTC’s claim emphasized that InterBill failed to follow its own merchant guidelines when processing these transactions, such as checking references, collecting information and verifying physical addresses.

Leveled by criminal charges

ISOs and payment processors are also vulnerable to other government actions and investigations, including criminal charges. In February 2006, CardSystems Solutions Inc. agreed to settle FTC charges that alleged the processor failed to take appropriate security measures to protect the sensitive information of tens of millions of consumers.

Also in February 2006, the U.S. government (not the FTC) filed a civil action against Payment Processing Center LLC and its principals. The suit alleged PPC either knew or remained intentionally ignorant of the fact that it was enabling merchants to engage in fraud, because it continued to process transactions for certain accounts with high return rates.

The PPC case was previously discussed in “Are you Big Brother material? The FTC seems to think so,” by Theodore F. Monroe, The Green Sheet, Sept. 11, 2006, issue 06:09:01. It is compelling because the government did not sue any of the 13 PPC merchants specifically alleged to have perpetrated the underlying acts of fraud.

In secret, the government also obtained a restraining order against PPC that barred the company from processing certain types of transactions. In addition, the order contained an immediate asset freeze.

And in January 2007, authorities brought criminal charges against John David Lefebvre and Stephen Eric Lawrence, the principals of a company that processed Internet gambling transactions.

The charges alleged the pair set up an Internet payment services company to help facilitate the transfer of billions of dollars of illegal gambling proceeds from American citizens to overseas Internet gambling companies.

Protective armor for payment processors

Worried? Here are some things you can do to avoid these types of government inquiries and lawsuits:

• Investigate your merchants’ business practices, and verify that they honor all promises they make.
• Carefully adhere to your underwriting guidelines, and look for inconsistencies in merchant applications.
• Halt processing services to merchants that may be violating the law or have unusual or high chargeback ratios.
• Review all marketing materials and telemarketing scripts.
• Obtain written documents demonstrating your merchants’ compliance with card Association and NACHA rules and regulations regarding consumer authorization of debits.
• Never process ACH transactions on behalf of merchants engaged in outbound telemarketing to consumers with whom such merchants have no existing relationship. Remember, this activity constitutes an unfair practice in the eyes of the FTC. And it violates the NACHA rules to which processors are contractually bound.

If you suspect your customers of violations, or if you receive a government inquiry concerning one of your merchant accounts, consult a lawyer with experience in the payments industry.

There are many ways you can be held responsible for your clients’ conduct. An attorney can help ensure that you do everything in your power to comply with the law and avoid a situation where you incur liability for aiding and abetting unlawful conduct.

The information contained in this article is for informational purposes only. Please consult an attorney before relying upon it for your specific legal needs. Theodore F. Monroe is an Attorney whose practice focuses on the electronic payment and direct marketing industries. For more information about this article or any other matter, please e-mail Monroe at monroe@tfmlaw.com

The post Think Chargebacks Are Bad? Look What Uncle Sam Can Do appeared first on Genco Payments.

The first step in responding is figuring out whether the processor is not paying the agent because it cannot, or is choosing to not pay for other reasons.

This in and of itself may prove challenging.

For example, where the processor has taken the action as a result of a civil investigative demand by federal regulatory authorities, the processor may be prohibited from disclosing the fact of the investigation to the agent or its merchants. The processor may offer a pre-textual reason for cutting off revenues in lieu of the real reason. The processor may simply stop responding to phone calls and emails and stop paying the agent without any explanation. Thus, getting to the truth often requires getting lawyers involved to exert pressure on the processor. That may be as simple as a telephone call, or may require the filing of a lawsuit.

On the other hand, the processor may be completely candid about its reasons for not paying.

Perhaps the processor can’t pay because its sponsoring bank or upstream partner has cut off its revenues. This might happen because of an investigation or lawsuit by federal regulators – such as the Federal Trade Commission (“FTC”) or the Consumer Financial Protection Board (“CFPB”) – or other action by the Card Brands regarding the processor itself, or problematic merchants within its portfolio.

In situations like this, the best strategy may be for the agent to step into the processor’s shoes and attempt to take ownership of the problem to eliminate the obstacle blocking the payment stream. Depending on the facts, that may mean funding the defense and settlement of federal regulatory claims against the processor and its upstream partners; advancing payment of Card Brand fines against the acquirer; and/or prosecuting breach of contract, indemnity and guaranty claims against the merchant (or merchants) that caused the problem.

Whether such an approach makes sense usually depends on a careful analysis of the agent’s potential return on investment. Many times, it may not make sense and the best choice may be to take the loss and walk away. This is especially true in cases where the amount at issue is painful–—but not devastating—to the agent’s business. It’s also true when the processor has plainly engaged in wrongdoing and appears to be going “down for the count” no matter what.

Perhaps the processor is choosing to not pay the agent for other reasons.

The processor may blame the agent for referring a bad merchant (or group of merchants) that has caused the processor problems with its upstream partners or federal regulatory authorities. As a result, the processor may have simply chosen to divert the agent’s residual stream to fund the associated legal costs according to its own subjective sense of justice.

Perhaps the agent actively referred merchants in the past and earns significant monthly commissions on those referrals, but has stopped sending new accounts to the processor in favor of a new business relationship. Many processors are quick to discover a contractual pretext for cutting off the revenue stream in “what have you done for me lately” cases, as I like to call them.

In these situations, the best strategy may be filing a lawsuit, subject to several qualifications.

First, the outcome in litigation is usually dictated primarily by leverage rather than by the question of who is right. Even though a contract may favor the agent’s legal position in a dispute so that the agent has a likelihood of prevailing on his claims, it may nonetheless favor the processor’s position with respect to question of leverage and the cost of “winning.”

Does the contract provide for prevailing party attorneys’ fees? If not, then each side will be responsible for paying its own lawyers. Therefore, whether it makes sense to sue may depend on the amount at issue relative to the anticipated time and cost of prosecuting the claim.

Does the contract contain a liability limiting clause capping the amount of any potential recovery, and/or prohibiting any claim for consequential or punitive damages? The contract may limit the amount or type of recoverable damages to such an extent that it’s simply not worth it to file a lawsuit.

Does the contract contain a mandatory arbitration provision?

Arbitration also means no jury and thus, presumably, a more dispassionate and sophisticated decision-maker to resolve the dispute, which is a leverage stick that may lean either way depending on the nature and underlying facts of the claim.

Arbitration often provides a more efficient mechanism for resolving a dispute, but may prove prohibitively expensive depending on the particular terms of the arbitration clause. Does it provide for arbitration before a single arbitrator or a panel of three arbitrators? How does it allocate the arbitration costs between the parties? Does it provide for an award of arbitration costs to the prevailing party? Where is the arbitration to be held and what rules apply?

The answers to these questions are key to a cost-benefit analysis for both sides and hence central to the question of leverage. Thus, even if the agent has the better side of the legal argument, these considerations may weigh against the agent filing suit.

In those situations, that may mean negotiating with the processor to achieve an acceptable compromise, like the agent setting up a separate reserve or receiving a reduced revenue stream for a period of time. Or it may mean that the better choice for the agent is to accept the loss and simply move its merchant portfolio to another processor.
In short, “what to do you when your processor stops paying you” is a multi-faceted question involving numerous practical and strategic considerations that goes far beyond a basic legal analysis and it defies a simple, formulaic answer.

The information contained in this article is for informational purposes only. Please consult an attorney before relying upon it for your specific legal needs. Theodore F. Monroe is an Attorney whose practice focuses on the electronic payment and direct marketing industries. For more information about this article or any other matter, please e-mail Monroe at monroe@tfmlaw.com

The post What to Do When Your Processor Won’t Pay You? It Depends… appeared first on Genco Payments.

Moreover, shifting political tides threaten major policy changes that could reverse prior advances toward a more favorable climate for such FIs. Twenty-five states and the District of Columbia have legalized marijuana in some form. Yet marijuana remains illegal under federal law.

As I discussed on my website, these differing viewpoints led the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) and the Department of Justice to issue separate guidance to banks more than two and a half years ago. Those guidelines had the goal of making fintech players more confident about offering financial services to legitimate state-licensed marijuana businesses, without fear of prosecution.

Since then, Visa and Mastercard have taken the position that local acquiring banks are best suited to make determinations regarding the legality of a marijuana-related merchant’s business. That is because the question represents an “evolving legal matter with different standards applicable in different states,” Visa stated.

Enforcement priorities

However, such guidance did not change federal law, but merely reflected a change in the federal government’s law enforcement priorities. Thus, FIs that extend merchant services to legal marijuana-related businesses remain subject to potential criminal and regulatory enforcement actions in the face of ever-shifting political tides and policy changes.

Indeed, the 2014 FinCEN guidance clarified how banks can extend services to marijuana-related businesses consistent with their obligations under the Bank Secrecy Act (BSA). The guidance recommends implementing appropriate anti-money laundering safeguards, including adequate customer due diligence, ongoing monitoring and proper suspicious activity reporting tailored to the marijuana industry.

Yet the concurrently released DOJ guidance emphasized the DOJ’s authority to enforce federal law regardless of state law. Thus, even for FIs that fully comply with the FinCEN guidance, the DOJ offered no safe harbor. Instead, it emphasized its discretion to investigate and prosecute FIs under money-laundering statutes and the BSA, where such action otherwise serves an important federal interest.

Therefore, most acquirers remain reluctant to offer financial services to marijuana-related businesses. Absent a change in federal law, banks that offer such services face the risk of potential criminal charges by the DOJ, or civil monetary penalties, cease and desist orders, fines and lifetime bans against responsible individuals from working in the industry by federal regulators.

Despite encouraging news in the past year, other recent developments suggest that such wariness is warranted. In both 2014 and 2015, Congress enacted amendments prohibiting the DOJ from spending funds to prevent any state from implementing its own laws authorizing the use, distribution, possession or cultivation of medical marijuana.

In August 2016, the Ninth Circuit Court of Appeals extended such protection for marijuana businesses by holding that these same appropriations riders prevent the DOJ from using such funds for the prosecution of individuals engaged in conduct permitted by state medical marijuana laws and who fully complied with such laws regarding use, distribution, possession and cultivation. However, the court emphasized that such protections are only temporary.

Flimsy protections

“Congress currently restricts the government from spending certain funds to prosecute certain individuals,” the court wrote. “But Congress could restore funding tomorrow, a year from now, or four years from now, and the government could then prosecute individuals who committed offenses while the government lacked funding.

Moreover, as of this writing, a presidential election looms and a new administration could shift enforcement priorities to place greater emphasis on prosecuting marijuana offenses. “Those admonitions should be taken seriously. Indeed, in April 2016, the Senate Appropriations Committee approved another amendment for fiscal year 2017 barring use of DOJ funds to investigate and prosecute legal marijuana businesses. Then, in June, the Senate Appropriations Committee approved a separate amendment prohibiting the Treasury Department from using funds to prohibit or penalize financial institutions solely because they provide financial services to state-legal marijuana businesses.

Nonetheless, that same month, House Republicans blocked a floor vote on the bank access amendment, and it appears they may also block a vote on the former amendment. Accordingly, there is uncertainty as to whether such medical marijuana protections will make their way into the final spending bill for fiscal year 2017.

Moreover, many believe New Jersey Governor Chris Christie is likely to be named attorney general in the event of a Trump presidency. Should that happen, many marijuana-related businesses and the banks that process for them may well end up in the federal government’s crosshairs.

The fiscal year ended on Sept. 30. Although existing marijuana protections are likely to be extended along with the current fiscal year’s funding until the Senate and House agree on a final spending package for fiscal year 2017, the future of such protections remains in doubt.

The information contained in this article is for informational purposes only. Please consult an attorney before relying upon it for your specific legal needs. Theodore F. Monroe is an Attorney whose practice focuses on the electronic payment and direct marketing industries. For more information about this article or any other matter, please e-mail Monroe at monroe@tfmlaw.com.

The post Pot Shop Processing Remains Risky Business appeared first on Genco Payments.

According to the FTC, many of these actions have targeted phantom debt schemes, and the failure of some collectors to give consumers legally required disclosures and notices, or to follow state and local licensing requirements.

This should be a wakeup call to those who process payments for debt collectors, particularly in light of the government’s increasing tendency in recent years to sue payment processors alongside bad merchants for enabling consumer fraud by extending them access to the payments system – especially where authorities identify deficient merchant underwriting or monitoring practices.

But what is a “debt collector” and what practices does the law prohibit?

FDCPA Covers Third-Party Debt Collectors Who Collect Consumer Debt

The Fair Debt Collection Practices Act (“FDCPA”) (15 U.S.C. §1692 et seq.) is the primary federal law that regulates the collection activities of debt collectors. The FDCPA broadly defines a “debt collector” as any person who regularly collects “consumer debt” owed to others, or collects its own consumer debts under a different name. Thus, the FDCPA generally covers hired or “third party” collectors, but not “first party” collectors (including company officers and employees) working internally to collect a consumer debt on behalf of an “original creditor.”

“Consumer debt” means personal, family, and household debts, such as money owed by a consumer on a personal credit card account, a car loan, a medical bill, or a mortgage, but does not include debts owned by businesses or by individuals for business purposes.

“Debt collectors” covered by the FDCPA include collection agencies, lawyers who collect third party debts on a regular basis, any company that regularly collects consumer debts for an unrelated company, and companies that buy delinquent debts and then try to collect them.

On the other hand, the FDCPA does not cover banks, credit card issuers, doctors, healthcare service providers, and other parties that collect: their own debts in their own name; debts which they originated and sold but continue to service (such as mortgage and student loan debts); or debts that were not in default when obtained by the purchaser.

FDCPA Prohibits Covered Parties from Using Abusive, Deceptive, and Unfair Practices to Collect Consumer Debt

The FDCPA prohibits debt collectors from engaging in conduct that harasses, oppresses, or abuses the debtor or any third party they contact.

Prohibited activities include threatening arrest, or threatening any other legal action against a debtor (e.g. wage garnishment or property attachment) unless they are permitted by law to take the action and intend to do so; and/or using deceptive means to collect a debt, including but not limited to publishing false credit information about a debtor, using “official-looking” documents to mislead the debtor, or using a false company name.

The FDCPA also prohibits covered parties from collecting “any amount (including any interest, fee, charge, or expense incidental to the principal obligation) unless such amount is expressly authorized by the agreement creating the debt or permitted by law.” (§1692(f)(1).) Most courts read this section to flatly prohibit debt collectors from charging transaction or convenience fees to consumers for accepting debit or credit cards to pay their debt unless expressly permitted under the contract that created the debt, or applicable state law. A number of other states have also enacted their own laws prohibiting debt collectors from charging such transaction fees, including Colorado, Washington and Wyoming among others.

“Original Creditors” Are Now Subject To Many Of The Same Standards Pursuant To The Consumer Financial Protection Act (“CFPA”) And Various State Statutes

The Consumer Financial Protection Bureau (“CFPB”) has also endeavored in recent years to extend many of these same standards to “first-party” debt collectors pursuant to its authority under the CFPA (Title X of the Dodd-Frank Act) to prevent “unlawful, deceptive, and abusive acts and practices” (“UDAAPs”). CFPB has repeatedly taken the position that many of the same types of activities proscribed by the FDCPA often constitute UDAAPs. Moreover, CFPB has plainly stated: “Original creditors and other covered persons and service providers under the Dodd-Frank Act involved in collecting debt related to any consumer financial product or services are subject to the prohibition against UDAAPs in the Dodd-Frank Act.” (CFPB Bulleting 2013-07.) Thus, while the FDCPA does not cover “first-party” collectors, CFPB has interpreted the CFPA’s prohibition against UDAAPs to embrace the same essential standards.

Furthermore, a federal district court in Georgia has recently agreed with CFPB and held that payment processors may be directly liable as service providers under the CFPA for proximately causing consumer injury if they process payments for merchants engaged in fraudulent activity that should have been detected by appropriate underwriting or monitoring practices.

State Law Varies Widely In Its Treatment Of Debt Collection Activities

Of course, the FDCPA’s protection extends to consumers in every state. Yet many states, including California, have also enacted their own consumer protection statutes (e.g. the California Fair Debt Collection Practices Act) extending many of the same prohibitions contained in the FDCPA to “original creditors.” Moreover, each state and U.S. territory has different licensing requirements for collection agencies, attorneys, and debt buyers, further complicating the legal backdrop against which such businesses operate.

Card Brand Rules Are Less Than Clear

MasterCard Rules prohibit a “Merchant from submitting to its Acquirer, or a Customer from submitting to the Interchange System, any Transaction that: 1. Represents the refinancing or transfer of an existing MasterCard Cardholder obligation that is deemed to be uncollectible; or 2. Arises from the dishonor of a MasterCard Cardholder’s personal check.” However, MasterCard Rules permit a Merchant to “submit a transaction with MCC 6051 (Quasi-Cash-Merchant) for the payment of an existing Cardholder obligation owed to the Merchant.” (MasterCard Rules (11 Dec. 2014), Rule 5.9.5 at p.85.)

While MasterCard does not define the phrase, a debt typically is “deemed to be uncollectible” when it has virtually no chance of being paid, and has been written off and/or farmed out to a collections agency by the original creditor. Thus, MasterCard Rules appear to prohibit a Merchant from accepting MasterCard in connection with “third-party” collection activities, but permit a Merchant to accept MasterCard in connection with “first-party” collection activities.

So, for example, it appears fairly clear that a dentist may charge a patient’s card for the past due balance on a root canal, or a lawyer may charge a client’s card for a past due services invoice, without violating MasterCard Rules, provided they use MCC 6051 for the transaction.

The result is murkier under Visa Rules.

Visa Core Rules prohibit a Merchant from accepting its cards to “collect or refinance an existing debt unless either: the Transaction results from the conversion of a Merchant’s existing card program to the Visa Program;” or “the Merchant is a government agency and the Transaction represents a loan payment.” (Visa Rules (Apr. 15, 2015), Rule 1.5.5.4 at p. CR-59.) Yet a standalone paragraph in the same Rule further states that:

At the option of Visa, a Merchant may accept a Visa Card … as payment for an existing debt. A Merchant must not accept a Visa Card … as payment for a debt that is considered uncollectible (for example: payments to a collection agency). This does not apply to a US Merchant.

(Rule 1.5.5.4 at p. CR-59.)

Okay, so what does that mean?

The ambiguous drafting of the latter clause means that Visa may subjectively interpret the Rule to permit or prohibit such transactions at its whim. As drafted, it is unclear whether or not the dentist or lawyer in our foregoing example can accept Visa as payment for an existing patient/client debt, and/or whether or not lawful debt collection agencies or other “third-party” debt collectors that comply with US law are acceptable Visa merchants, or may be under certain circumstances.

American Express identifies “debt collection agencies” as a prohibited merchant category (MCC 7322). But what exactly is the scope of that classification? Again, the lack of an accompanying definition means that American Express may subjectively interpret the term “debt collection agencies” to prohibit a far broader range of merchants than the name of the classification might otherwise imply.

Of course, MasterCard, Visa and American Express all plainly prohibit their acquirers from submitting any illegal or brand-damaging transactions to the payments system. Thus, given the complexity of the legal landscape surrounding collections activities, processing for debt collectors always carries a heightened risk of running afoul of both the law and the card brands, even in the case of “first-party” collections.

Consequences of Deficient Underwriting and Monitoring

In March 2015, the CFPB filed suit in US District Court for the Northern District of Georgia against several individuals and companies (the “Debt Collectors”) for running a fraudulent debt collection scheme using deceptive, abusive and unfair practices to trick consumers into making debit and credit card payments on “phantom debt” (i.e. debt that was not owed) in violation of both the FDCPA and CFPA, in an action styled CFPB v. Universal Debt & Payment Solutions, LLC, et al., Civil Case No.1:15-cv-00859-RWS.

CFPB also sued the payment processor and two of its ISOs (the “Payment Processors”) for boarding Debt Collectors, and allegedly failing to discharge their respective merchant underwriting and monitoring obligations. Notably, CFPB contends Payment Processors are both (1) directly liable for their own unfair practices as “service providers” under the CFPA, and (2) secondarily liable for “substantially assisting” Debt Collectors’ scheme, based on their role in facilitating the Debt Collectors’ access to the payments system by approving and continuing to process for Debt Collectors in plain violation of their own merchant underwriting and monitoring policies.

Among other things, CFPB alleges that Payment Processors approved Debt Collectors as merchants despite the fact they listed home addresses as purported business locations on their merchant applications, faxed their applications from a FedEx Office, listed the same business addresses for different businesses, and had an ex-felon for a CEO, who shared the same home address with another of Debt Collector’s principals who had low income and bad credit; and despite the fact the processor specifically identified “collection agencies” as “prohibited merchants” under its own credit policy.

CFPB further alleges that Payment Processors continued to process payments for Debt Collectors, despite high chargeback rates, detailed chargeback complaints of UDAAP violations and other fraudulent activity, and evidence of factoring, and even after MasterCard issued a MATCH alert for one defendant, Visa prohibited another defendant from using its network, and Discover demanded the termination of another of defendant’s merchant accounts.

Significantly, in September 2015, the district court denied Payment Processors’ motion to dismiss the action, holding that CFPB’s allegations plausibly supported its claims against them. As the district court stated: “[Payment Processors] knew the risks debt collectors pose, had a duty to investigate suspicious activity, and in the face of numerous warning signs of a debt-collection scheme permitted the Debt Collectors to continue to process payments anyway. In this way [Payment Processors] facilitated the Debt Collectors’ unlawful acts by giving them the tools they needed to use bankcard information to draw on consumers’ accounts-predictable consequences of ignoring consumer complaints about unauthorized charges and signs the debt-collection merchants were not legitimate businesses.”

The action is still pending

Yet given the government’s intense focus on the debt collection industry, and avowed eagerness to extend liability to processors who knowingly or recklessly facilitate bad merchants’ access to the payments system, we should certainly expect to see more payment processor and ISO defendants in further actions by the CFPB, FTC and other federal and state regulatory authorities as they continue to move forward with Operation Collection Protection in 2016.

The post Processing for Debt Collectors Means Big Risk to Payment Processors and ISOs appeared first on Genco Payments.

Since that time, federal regulatory agencies have made a standard play of aggressively investigating acquiring banks and third party processors for potential “aider and abettor” liability anytime their merchants are suspected of engaging in consumer fraud. Where such investigations perceive shoddy underwriting or deficient monitoring practices, acquirers and ISOs alike face liability for facilitating their merchant’s “bad acts” by extending access to the payments system.

Two recent lawsuits exemplify the government’s approach in such situations: (1) the Federal Trade Commission’s (“FTC”) lawsuit against the ISO and sales agents allegedly responsible for processing more than $26 million in illegal transactions for Jeremy Johnson and the IWorks enterprise, hereinafter the “CardFlex Action”; and (2) the Consumer Financial Protection Board’s (“CFPB”) lawsuit against the merchant processors and ISOs allegedly responsible for processing millions of dollars in “phantom-debt” payments for a group of merchants engaged in a fraudulent debt-collection scheme, hereinafter the “Global Payments Action.”

The CardFlex Action

In December 2010, FTC sued the now infamous Jeremy Johnson and his company, IWorks, Inc. (“IWorks”), along with nine other individuals and companies, and the dozens of shell companies they used to carry out the fraud. More than three and a half years later, in July 2014, FTC also finally got around to suing the ISO – CardFlex, Inc. – and sales agents allegedly responsible for facilitating more than $26 million in illegal transactions for the IWorks enterprise.

FTC alleges that Johnson first met with CardFlex’s principals, Andrew Phillips and John Blaugrund, in June 2009. Despite the fact that four separate banks had already placed Johnson on MasterCard’s Merchant Alert To Control High-risk merchants (MATCH) list since 2006, and Harris Bank alone had terminated 13 merchant accounts associated with Johnson just the preceding month, CardFlex not only decided to do business with IWorks, CardFlex even chose to loosen the underwriting requirements for Johnson’s accounts.

Shortly after their meeting, Phillips allegedly emailed Johnson a “personal guarantee” form to keep on hand and use for each merchant account application to be submitted by IWorks. Johnson explained his understanding of the arrangement to IWorks employees by stating that, as long as he signed a personal guaranty, CardFlex would open “any account in any name or corp we want” without requiring much “financial info.” As another IWorks employee described the deal, “CardFlex will set up merchant accounts with “basically ‘no questions asked’ (that is why we went with CardFlex).’”

FTC also alleges the CardFlex defendants knowingly submitted fraudulent merchant applications to the acquirer, including (i) routinely concealing the affiliation between the shell corporation and IWorks when they completed merchant applications on IWorks’ behalf, (ii) falsely certifying they had conducted onsite inspections of merchant offices that did not exist, and (iii) papering the applications with dummy webpages (known as “bank pages”) for underwriting purposes that, unlike the real IWorks’ websites, conspicuously displayed the terms of IWorks’ negative option offers. By such practices, the CardFlex defendants allegedly boarded 293 merchant accounts in the names of 30 separate straw corporations on IWorks’ behalf in less than a one-year period.

CardFlex did this even though Phillips knew the IWorks accounts had serious chargeback issues no later than the first month of processing. For example, in a September 2009 email, Phillips not only thanked Johnson for a Pebble Beach golf trip, but also cautioned him that “everyone of your accounts is at 3% and above and this is month one.” Nonetheless, CardFlex proceeded to open more than 200 additional merchant accounts for IWorks over the next three months. By early December 2009, Wells Fargo had already shut down at least 14 of those merchant accounts for excessive chargebacks, with many of those accounts posting chargeback rates of 5% to 6%.

Phillips responded by instructing IWorks to begin “load balancing” (i.e. spreading transaction volume among numerous accounts) to avoid triggering chargeback monitoring program minimum-transaction-per-account thresholds, and even suggested that IWorks (i) staff a single person to perform “load balancing full time” and (ii) obtain “multiple signers” for each corporation rather than using the same five-to-six “signers” for all of its corporations. CardFlex also provided IWorks with the efficient means to “load balance” their accounts online by simply checking a box titled “Enable Load Balancing for Credit Cards,” and then entering the relevant account information.

By the time Wells Fargo finally put the brakes on the operation and terminated its relationship with CardFlex in June 2010, a look-back review of CardFlex’s total merchant processing portfolio revealed that CardFlex had processed more than $387 Million in credit card volume with an overall chargeback ratio of 3.34% through March 2010 alone.

FTC settled with the last three remaining processing defendants in the CardFlex Action – CardFlex, Phillips and Blaugrund – in March of this year by entering a stipulated Permanent Injunction banning each of them for life from acting as a payment processor, ISO, or sales agent for certain types of high-risk merchants; and entering a $3.3 million monetary judgment against CardFlex and Phillips that will be partially suspended based on their current financial condition, but which will come immediately due in full in the event FTC determines they misrepresented their financial condition in any way. The CardFlex defendants are also subject to compliance monitoring requiring them to furnish FTC with annual reports concerning their business activities for the next 10 years.

The Global Payments Action

No later than FTC had finished putting the CardFlex Action to bed, CFPB filed suit under the Consumer Finance Protection Act (“CFPA”) and the Fair Debt Collection Practices Act (“FDCPA”) against a group of merchants allegedly engaged in a fraudulent debt collection scheme (“debt collectors”) and the third party payment processors responsible for facilitating their access to the payments system, specifically including Global Payments, Inc., Electronic Merchant Services, and their respective ISOs (the “Processors”).

CFPB bases its action against the Processors for deficient underwriting and merchant monitoring practices in violation of both card association rules and Processors’ own risk management policies. Generally, CFPB alleges that, even though (i) card association rules prohibit merchants from accepting a Card to collect or refinance an existing debt, (ii) Global’s own credit policy specifically identified both collection agencies and “Aggregators” as “prohibited merchants,” and (iii) debt collectors were Card Not Present (“CNP”) merchants subject to mandatory enhanced scrutiny under Global’s own policies, the Global defendants approved debt collectors’ numerous applications for payment processing accounts and failed to reasonably monitor those accounts for signs of unlawful conduct.

Merchant Underwriting Problems

In March 2011, despite the fact that Global’s underwriting purported to include a review for criminal activity, associates, and verification of addresses, business filings or corporate affiliations, Global approved co-defendant Mohan Bagga’s merchant application for “Credit Power, LLC” even though its “chief executive officer” had recently finished a sentence for drug trafficking and shared Bagga’s address listed on the application. In November 2011, Global approved a second merchant application for Bagga in the name of Universal Debt and Payments Solutions (“UDPS”), even though (i) Global’s own policies identified a merchant’s use of the word “Payments” in its legal name or DBA as a red flag for factoring; (ii) Bagga listed his residence address as the business address (a recognized red flag that a business may not be legitimate); and (iii) Bagga’s poor credit history and status violated Global’s own underwriting standards.

Global also approved additional merchant accounts for Credit Power and UDPS through other ISOs based on similarly deficient underwriting practices. UDPS’ March 2013 application identified a physical and legal address it never occupied, and the fax imprint shows the application was faxed from a FedEx Office location, and the address on the voided check UDPS provided with its application belongs to another collection agency. While the application clearly stated that UDPS was in the business of “debt collections,” the underwriting summary used the MCC for “Family Clothing Stores.” Credit Power’s April 2013 application identified an address for a UPS Store, and was faxed from the same FedEx Office as the UDPS application. The underwriting summary included a BBB review giving Credit Power an “F” rating and identifying its principal as an ex felon.

Processors Ignored Many Other Red Flags

CFPB further alleges that, once Credit Power and UDPS began processing, Processors continued to ignore other red flags.

For example, in January 2012, one of the ISOs recognized that UDPS was processing payments for RSB Equity Group, LLC (“RSB”). Although Global’s policy prohibited processing payments for another merchant, or “factoring,” Processors allowed UDPS and Credit Power to continue processing payments. In November 2012, one of the ISOs received a MATCH alert for UDPS and RSB. The MATCH alert stated that another processor terminated affiliates of UDPS and RSB because the processor, after investigation, found factoring and excessive chargeback volume. Although the ISO had identified this same factoring conduct by RSB and UDPS in January 2012, it did not conduct any further investigation.

In March 2013, Global notified the ISO that Visa had prohibited Credit Power from processing payments using the Visa network. However, Processors continued to allow Credit Power and UDPS to process payments with other card brands. On July 8, 2013, Discover Card shut down UDPS’s account due to “prohibited business practices.” Yet the Processors still allowed UDPS and Credit Power to continue processing MasterCard transactions for almost another year, despite chargeback rates of up to 28.5% in July 2013 and 31% in August 2013.

Conclusion

In addition to DOJ’s recent criminal actions against CommerceWest Bank (for knowingly facilitating wire fraud by certain telemarketing and payday loan merchants) and Plaza Bank (for knowingly facilitating wire fraud by merchants selling identity theft protection insurance), and CFPB’s civil action against PayPal for deceptive or unfair practices in connection with PayPal Credit, the CardFlex and Global Payments Actions suggest that Operation Choke Point is very much alive, and that third party processors remain very much under scrutiny.

How does your TPP/ISO Agreement allocate responsibility for merchant underwriting and monitoring? Are your company’s underwriting criteria and risk management practices up to snuff? How complete are your underwriting files? How do your advertising materials look from a regulator’s perspective? Wherever you are situated in the payments hierarchy, these are all questions you should look at before the federal government does.

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