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DT, December 2016

The New Battle: Surcharge Fraud
December 1, 2016

By Alex Nouri

How some unscrupulous players are bilking unsuspecting merchants by promising fast—but expensive—ways to recover acceptance costs.

A surcharge is a fee that is added to a card transaction, either as a set amount or a percentage of the transaction, typically to allow the merchant to recover all or part of the transaction fee. It has been a controversial issue for years, and lately it has become even more so as unscrupulous merchant-service providers use it as a way to take advantage of unwary merchants.

Historically, surcharging has been allowed for a few emerging industries such as government, rental real estate, utilities, and schools. These industries call the surcharge a “convenience fee.”

Whether surcharging is allowed for all other merchants, either face-to-face or e-commerce, is an uncertain matter. Visa and MasterCard reached a legal settlement in 2012 and implemented it in 2013 allowing these merchants to add surcharges in all but 10 states, where it is prohibited by law. But earlier this year that settlement was overturned by a federal appeals court, leaving the matter in legal limbo for the time being.

As a result, there are different opinions on whether and when card transactions can be surcharged, leaving the door open to speculation. I believe the following information, verified recently by both sides in the 2012 settlement, will answer most, if not all, questions and uncertainties.

The Rules

Visa Core Rules and Visa Product and Service Rules Section 5.6 offer clear and strict guidelines on surcharging by merchants based in the U.S. The following conditions have to be met:

- Merchant cannot impose a surcharge if other card brands do not allow it;

- Merchant has to inform the acquirer and Visa in writing at least 30 calendar days before implementation of surcharge;

- Surcharge is not allowed on debit (check) cards as well as on PIN-based debit and prepaid cards. A gift card is a prepaid card;

- Merchant has to post conspicuous signage at the point of entry and at the point of sale stating that a surcharge is being assessed by the merchant and is only applicable to credit transactions. The disclosure has to state the exact amount or percentage of the surcharge. The dollar amount of the surcharge must appear on the transaction receipt;

- The signage must make it clear to the cardholder that surcharges are not permitted on debit transactions regardless of whether a cardholder selects the credit or debit button;

- The point-of-sale disclosure must read that the U.S. credit card surcharge amount is not greater than the applicable merchant discount rate at the merchant location. In no event could the surcharge be greater than 4%. The merchant discount rate is the same as the effective rate, and it does not include monthly equipment fees due to equipment lease or rental;

- For electronic commerce (Web), mail order-telephone order (MOTO), and an unattended transaction, the cardholder must be provided the opportunity to cancel the transaction subsequent to the surcharge disclosure;

- Surcharging is allowed only in the U.S. and U.S. territories. The following 10 states do not allow surcharging: California, Colorado, Connecticut, Florida, Kansas, Maine, Massachusetts, New York, Oklahoma, and Texas.

- Surcharging is prohibited outside of the U.S. except if a local law or variance allows merchants to engage in the practice.

MasterCard Operating Manual Rule 5.9.2 offers similar guidelines on adding a surcharge to transactions, except that it does not mention a cap of 4%. Merchants can provide a discount for cash transactions, a practice exercised by many petroleum stations in the U.S.

American Express does not allow surcharging. That stance was upheld in September in a landmark decision by a federal appellate court.

Bogus Claims

But the Visa and MasterCard rules on surcharges are vague enough that they are open to interpretation and abuse. Merchants are tempted to add surcharges to defray their processing costs. However, I have recently witnessed a new type of fraud by unscrupulous salespeople, their independent sales organizations, and a few leasing companies. This fraud stems from the abuse of the 2013 rules on surcharging.

A few registered ISOs and their agents are deceiving merchants by telling them surcharging is allowed all over the world, that consumers don’t mind it, that surcharging is allowed on all card types, that the merchant could gain substantially by passing on the cost to consumers, and that their company actually holds a patent on surcharging.

All these claims, of course, are bogus.

But the swindle goes farther than that. These companies claim that only they have the necessary software to process surcharges, at a cost of up to $3,000 per point-of-sale device. The merchant, already drooling over the prospect of zero processing cost, trusts these con artists. He agrees to sign up for a non-cancelable terminal-leasing contract for up to 60 months and up to a staggering $150 per terminal per month.

These operators usually sign merchants up for two devices, the second one being useless and sometimes not even delivered. The ISO or the processor underwrites the account, and the processor takes on the processing, sometimes not even knowing about the surcharging shenanigans.

The leasing agent makes off with between $3,000 and $4,000 per device and is paid the commission the very next day by the leasing company. This is huge income, too good to pass up.

And, for the leasing companies, it can get even better. One small merchant I know was told by a leasing company recently that he has to pay $9,000 to buy out the lease for two devices and cancel his merchant contract. There was not a need for a second unit.

Swindling is a felony in all states. Yet these parties do it and get away with it, right under the noses of Visa and MasterCard, the processors, and the acquiring banks.

The terminal of choice is usually one that, first, allows adding a surcharge as a line item at the terminal level, and, second, lets the ISO hold the master password to the terminal, therefore ensuring merchants are locked in and cannot switch processors.

Also, processors do not have to, and will not, know surcharges are being assessed, nor do they care to know as long as they will not be in a non-compliant status on surcharging rules. And the acquiring/sponsor banks have a totally hands-off approach, as usual.

I must note that the terminal manufacturers do not participate in these schemes. Still, in my opinion, they should not allow surcharging by their devices, or at least they should be part of a comprehensive solution.

Drawbacks

Surcharges may appear to save merchants processing costs by passing these costs on to cardholders. But the majority of consumers frown on it. No consumer wants to pay more. Marketers offer discounted prices, not increase the price, to increase sales.

On the accounting side, the added surcharge is reported to the Internal Revenue Service by processors as taxable income. So, the gain is diluted by the tax.

Most important, it is virtually impossible to set up surcharging because no device or software program can distinguish between credit, debit, branded gift cards, and American Express. All cards are surcharged during a transaction.

To make themselves believable, these unscrupulous reps invoke the discount given by petroleum stations. The fact is their POS is set up to offer a discount on cash, which is quite different from adding a surcharge on card transactions.

Additionally, merchants often do not know the difference between a credit, debit, and branded gift cards. So, by adding a surcharge to all cards, they would certainly be in violation of the rules.

How to React

Visa and MasterCard should care more about this activity. I know from personal recent experiences both companies come up severely short in offering assistance and enforcing their own rules.

Inadequate enforcement signals to violators that they can continue with no fear of consequences. Indeed they can and have been doing it ever so audaciously. This has attracted others with nefarious mindsets. And yet others may be tempted to follow the same path.

I strongly admonish merchants against signing up for surcharging services. It will most likely cost them more down the line than what they think they may save. And, depending on what state they operate in, they may be in violation of the law.

Leasing companies should do their due diligence and run background and credit checks on their agents, cap monthly payments, refuse to accept the Delivery and Acceptance form with the original lease document, record the installation call, and send a welcome letter offering a 30-day cancelation period, with full recourse to merchants.

They should also be completely transparent and provide copies of all documents and audio recordings to merchants when requested. Not adhering to these policies is what attracts the gators. The few leasing companies that are assisting these greedy gangsters know exactly what they are doing.

ISOs and processors, too, should avoid setting up such merchant-processing accounts until American Express allows surcharging (for merchants who do accept American Express credit cards), and only if the specific aforementioned rules are adhered to.

What compounds this problem is when the ISO itself is a registered ISO of the larger registered ISO and provides its own technical support. This virtually ensures a self-contained operation giving the lower ISO absolute control over all operations and virtually guaranteeing the merchant will never know the name of the main ISO and the processor. The lower ISO and its agents continue to operate while enjoying impunity.

The appeals court’s decision overturning the big 2012 settlement introduces uncertainty, but it doesn’t mean the immediate demise of surcharging. There is a chance the practice will be withdrawn at a later date by Visa and MasterCard, which means more gloomy news for merchants who have already signed onto non-cancelable equipment leases.

This type of fraud will grow substantially if Visa and MasterCard, processors, ISOs, acquiring banks, law enforcement, prosecutors, and lawmakers close their eyes and ears and walk in the other direction.

—Alex Nouri is the president of EFT Direct, Ann Arbor, Mich. He can be reached at alex@eft-direct.com.


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