Acquiring: ISOs Enter the Age of Regulation

Linda Punch

Time was, regulators largely left independent sales organizations and other acquirers alone. Now, with a trio of major enforcement actions, the Federal Trade Commission is showing how those days are over.

For entities that play such a key role in the acquiring industry, independent sales organizations have led a charmed life when it comes to regulators.

While banks, processors, and other players in the bank card arena must deal with a wide array of regulations and multiple agencies, ISOs historically have been subject only to the rules of the bank card networks and the (voluntary) standards set by the acquiring-industry trade group, the Electronic Transactions Association.

Now, that appears to be changing.

Over a two-month period this summer, the Federal Trade Commission filed complaints against three ISOs and their affiliates, alleging violations of the federal Telemarketing Sales Rule in two cases and deceptive and misleading sales practices in the third. The suits are viewed by many as a clear message to the acquiring industry from the FTC: Federal regulators are serious about policing ISOs and other merchant processors.

“I view these [complaints] as alarming for the industry and as a very loud warning bell,” says Holli Targan, partner with Southfield, Mich.-based Jaffe, Raitt Heuer & Weiss PC. Targan is a former president of the Electronic Transactions Association and a member of the ETA’s executive board.

The flurry of FTC enforcement activity began on June 4, when the agency filed an amended complaint in the U.S. District Court for the Middle District of Florida accusing a Clearwater, Fla.-based telemarketer, Innovative Wealth Builders Inc., of using deceptive tactics to sell services that would allegedly reduce consumers’ credit card interest rates.

The complaint also named as a defendant Independent Resources Networks Corp., a Westbury, N.Y.-based ISO that handled IWB’s card transactions from August 2009 until January, when IWB was enjoined by a court order, the FTC said.

IRN is charged with violations of the FTC Act and the Telemarketing Sales Rule. The FTC is seeking an injunction against the defendants and unspecified relief for the allegedly defrauded consumers.

The FTC alleges IRN abetted IWB by processing its transactions, lending it cash advances totaling “hundreds of thousands of dollars,” and advising it on how to combat chargebacks. IWB’s monthly chargeback rate rose above 40% “multiple times” during the period IRN processed its transactions, according to the complaint. The average chargeback rate from January 2010 until January 2013 was greater than 20%, it said.

The FTC complaint also alleges that IRN took steps to protect itself, requiring IWB to pay into a reserve account, for example, that totaled $700,000 by the time the FTC filed its suit.

The ISO continued processing for IWB even though it knew, or “consciously avoided” knowing, that the telemarketer was charging fees of $500 to $2,000 for rate-reduction services it never delivered, the complaint alleges.

Barrie VanBrackle, co-chair, Consumer Financial Services, at Manatt, Phelps & Phillips, is representing IRN in the FTC case but won’t comment on the specifics of the complaint.

Mirror Image

In the second action, filed June 21, the FTC added Newtek Merchant Solutions and its former president Derek Depuydt as defendants in an amended complaint against a Florida telemarketer that the FTC alleges defrauded consumers. It is a near mirror-image of the IWB-IRN case.

As in the case against IRN, the agency says Newtek abetted a scheme to defraud consumers by processing transactions for a telemarketer that was selling an allegedly bogus rate-reduction service to credit card holders. Newtek processed $2.8 million in transactions for the telemarketer, Treasure Your Success (TYS), over a nine-month period ending July 2012, despite inordinately high chargeback rates, the FTC contends.

Newtek also neglected to obtain telemarketing scripts before granting a merchant account to TYS, the agency alleges. Nonetheless, Newtek withheld as much as 20% of the telemarketer’s proceeds each month to fund a reserve account against chargeback losses, according to the complaint.

The complaint, filed in the Orlando division of the U.S. District Court for the Middle District of Florida, accuses the defendants of violations of the FTC Act and the TSR, and asks for an injunction and unspecified reimbursement for consumers. The 18-year-old TSR makes it a violation to give “substantial assistance” or support to fraudulent telemarketers.

Milwaukee-based Universal Processing Services of Wisconsin LLC, which does business as Newtek Merchant Services, did not return calls for comment for this story. However, in response to a Digital Transactions News request for comment when the complaint was first filed, UPS president Eric Turille said, “We know based on our own internal practices that we have always attempted to abide by the law.”

Familiar Violation

But the FTC wasn’t done. Within weeks of charging IRN and Newtek with TSR violations, the regulator filed a complaint charging Spokane, Wash-based Merchant Services Direct LLC (MSD) with a more familiar violation: deceptive marketing practices.

The FTC on July 30 charged MSD with making false and unsubstantiated claims and failing to disclose material facts to merchants seeking services and equipment to process credit and debit card payments. The FTC is seeking to halt the allegedly illegal practices and return money to victims. The Washington State Attorney General’s office filed similar charges against the ISO in the Superior Court for Spokane County.

MSD also does business as Sphyra Inc., Boost Commerce Inc.; and Generation Y Investments LLC. Other defendants are company executives Kyle Lawson Dove and Shane Patrick Hurley. A spokesperson could not be reached for comment.

The complaint was filed in the U.S. District Court for the Eastern District of Washington.

According to the FTC complaint, MSD sales agents allegedly cold-called small businesses and led them to believe they were associated with the businesses’ current card processor, Visa or MasterCard, or their bank. The sales agents then allegedly promised substantial savings on credit and debit card processing fees.

The sales agents specified a much lower fixed-rate fee than the businesses currently paid, but didn’t mention all the other fees the businesses would have to pay, the complaint alleges. Merchants who asked if there were other fees allegedly were told there were none.

On various versions of its Web sites, the ISO also advertised “Guaranteed Lowest Rates,” claiming merchants could “save 30%” with “whole sale [sic] processing” or have “anywhere from 20% to 30% savings when switching to” MSD. In fact, according to the FTC, there were no wholesale rates, as third parties process card payments, not MSD.

MSD agents also allegedly duped some customers into leasing new card-processing terminals for two to four years, falsely claiming their current “swipe” terminals were outdated or incompatible with its services, according to the FTC complaint. Agents allegedly persuaded merchants to sign fine-print, binding contracts on the spot by telling them the documents were merely applications—a ruse made easier, the FTC said, by the fact that the contracts were labeled “applications.”

Merchants were often falsely told they could cancel at any time. Many victims discovered their new lease obligation only after being billed, still owing the balance of their previous lease, which can be thousands of dollars.

The FTC complaint charges that merchants who called MSD’s customer-service department reached employees who either did not help them or said they would waive fees or provide refunds but didn’t. Customers who were promised they could cancel the “applications” they signed with no penalty were charged substantial cancelation fees, the FTC alleges.

Generally, the ISO refunded money or waived fees only in response to complaints filed with the Better Business Bureau and state attorneys general.

While the acquiring industry has been trying for decades to put an end to deceptive marketing, such practices continue to be commonplace, Targan says. But the FTC’s stepped-up scrutiny of the card-processing business raises the stakes for ISOs engaging in unfair or deceptive acts.

“Companies need to take a look at how sales are being performed and make sure that deceptive and misleading practices are not being pursued by their sales representatives,” she says.

And ISOs aren’t the only targets of the FTC. In March, the agency reached a settlement with payment processor Automated Electronic Checking Inc. and two of its principals, which allegedly processed fraudulent and unauthorized transactions for EdebitPay LLC and Platinum Online Group, two companies that allegedly violated the FTC Act.

Under the settlement, AEC must pay the $950,000 it earned from processing for EdebitPay and Platinum. The money will be returned to consumers harmed by AEC’s actions.

AEC also is banned from processing electronic payments, resolving charges that the processor debited, or tried to debit, millions of dollars from consumers’ bank accounts without their consent.

According to the complaint, AEC processed more than $49.8 million in transactions for the two companies between February 2008 and November 2010, despite consistently high return rates. The banks had notified AEC of the specific reasons for the high return rates, and AEC knew the principals of both companies were already subject to an earlier FTC order, the FTC said.

The companies did not return calls for comment for this story.

While the FTC has filed complaints against ISOs in the past for deceptive-marketing practices, the IRN and Newtek cases mark the first time the agency has charged an ISO with violation of the Telemarketing Sales Rule, Targan says. Indeed, most in the industry weren’t even aware they had to pay attention to the TSR.

“That’s not to say they shouldn’t have been because right there in the rule, it says anyone that provides substantial assistance or support to telemarketers can be liable as much as the telemarketers are themselves,” she says. “It’s just that there wasn’t a focus on it previously.”

‘Under the Radar’

Just what is behind the FTC’s newfound interest in ISOs and the acquiring industry is unclear. Some believe the ISOs are collateral damage in regulators’ long-time battle against telemarketing fraud. Historically, regulators have been unable to shut down most fraudulent operations until after consumers have suffered heavy losses.

The FTC sees removing their sources of payment processing as one way to close down fraudulent telemarketers, says Adil Moussa, principal of Adil Consulting. That means treating ISOs and acquirers as participants in the fraudulent scheme if there is evidence they knew a telemarketer had excessively high chargeback rates or showed other red flags of illegal operations.

“One of the ways to curb [telemarketing fraud] is to work with ISOs and acquirers and tighten the screw so there is some kind of shared responsibility if something happens,” Moussa says.

The industry uproar over the Durbin Amendment also may have drawn attention to the acquiring business and ISOs, Targan says. “The whole Durbin Amendment [fracas] brought a focus on the industry,” she says, adding it may have made regulators more aware of industry practices.

Whatever the reasons, the FTC’s stepped-up activity is likely to continue. “The acquiring business, including the ISO business, has always sort of flown under the radar of the regulators,” Targan says. “That era is over.”

Adds Henry Helgeson, chief executive of Merchant Warehouse, a Boston-based ISO: “I don’t think we’ve seen the end of this. I’m hearing rumors that there is still a deeper look going on within the acquiring industry.”

The FTC’s recent actions show that the if an ISO or acquirer “is going to turn a blind eye to a merchant who is committing fraud against consumers and at the same time protect themselves by taking reserves and limiting their own losses,” then the FTC considers the ISO complicit and liable for the telemarketer’s fraudulent actions, Helgeson says.

‘Pretty Serious Stuff’

With the FTC putting acquiring industry practices under the microscope, ISOs will have to be more vigilant about ensuring their sales practices and procedures comply with regulations. Targan says ISOs should be particularly “cognizant of the warnings” given in the FTC’s complaints.

“Absolutely every single ISO out there should be looking at their practices and their procedures in sales, whether it’s in-house, direct sales channels, or it’s independent contractors who are selling for them or it’s ISO organizations,” she says.

ISOs and acquirers should carefully scrutinize their underwriting criteria to make sure they screen out high-risk or fraudulent merchants, Helgeson says. “Look at the Web sites, look at the marketing materials, consider everything about this business type, and use some good judgment,” he says. “Is this something a consumer is going to be satisfied with if they buy this product.”

ISOs also need to use basic risk-management strategies, Helgeson says. “When you see very high chargeback ratios, ISOs and acquirers should be acting on those,” he says. “It shouldn’t be about profit margin when you start to see these. There are bigger issues than making a couple of bucks on a certain merchant.”

Many ISOs and acquirers studiously avoid signing high-risk merchants such as telemarketers. But even those ISOs could be at risk of running afoul of the FTC, Helgeson says.

“There have been a lot of portfolios handed over back and forth through acquisitions, through portfolio sales, and some acquirers may not even know they have these merchants in there because the chargebacks haven’t hit yet,” he says. “We went through this ourselves. We jettisoned about 200 accounts because we didn’t like the business types.”

With the FTC’s increased scrutiny of the acquiring industry, ISOs will have to put more effort into monitoring their merchants, says VanBrackle of Manatt, Phelps & Phillips.

But even with stepped-up monitoring, ISOs are “not going to catch everything,” VanBrackle says, noting that a large ISO can sign up to 10,000 merchants a day. And an ISO can be following standard industry practices and still unintentionally violate FTC regulations. In the case of IRN, “they were informed, they monitored chargebacks, and they followed the onboarding-of-merchants standards that are generally used in the industry,” she says.

It will be some time before the long-term implications the FTC actions have for ISOs and the acquiring industry will be clear. “We’re getting into some murky water right now,” Helgeson says.

Nevertheless, no one should take the FTC’s complaints lightly. “What they’re driving at and what these lawsuits are looking like is pretty serious stuff,” he says. “Everybody should be going through their books. This could be something that ruins a business.”